U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-KSB
[X] ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
FOR
THE FISCAL YEAR ENDED JUNE 30, 2006
[
] TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR
THE TRANSITION PERIOD FROM _____ TO ______
COMMISSION
FILE NUMBER: 000-32195
PGMI,
INC.
(Name
Of
Small Business Issuer In Its Charter)
|
Utah
(State
or other jurisdiction of
incorporation
or organization)
|
87-0319410
(I.R.S.
Employer
Identification
No.)
|
5912
Bolsa Avenue, Suite 108, Huntington Beach, California
92649
(Address
Of Principal Executive Offices)
ISSUER’S
TELEPHONE NUMBER: (714)
895-7772
SECURITIES
REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
|
TITLE
OF EACH
CLASS
|
NAME
OF EACH EXCHANGE ON
WHICH REGISTERED
|
|
N/A
|
N/A
|
SECURITIES
REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON
STOCK, NO PAR VALUE
Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act. o
Check
whether the issuer: (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes ý No
o
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained,
to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. ý
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes
o No
ý
State
issuer’s revenues for its most recent fiscal year: $24,485,146
State
the
aggregate market value of voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity
was
sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days: September 15, 2006, Common
stock, $0.01 par value: $5,632,576.
State
the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date: 25,003,671 Shares as of voting common stock
as of September 15, 2006
DOCUMENTS
INCORPORATED BY REFERENCE
None
Transitional
Small Business Disclosure Format: Yes o No
ý
PGMI,
INC.
ANNUAL
REPORT ON FORM 10-KSB
FOR
THE FISCAL YEAR ENDED JUNE 30, 2006
TABLE
OF CONTENTS
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Page
Number
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PART
I
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PART
II
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| Financial Statements | ||
| Item 8 | Changes in and Disagreements with Accountants | |
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PART
III
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||
| Item 14. | ||
PART
1
Forward
Looking Statements
This
Annual Report on Form 10-KSB of PGMI, Inc. (“PGMI” or “we”) contains
forward-looking statements that are not based on historical facts and are
based
on current expectations that are subject to various risks and uncertainties,
as
well as assumptions that, if they do not materialize or prove incorrect,
could
cause our future results to differ materially from those expressed or implied
in
such forward looking statements. All statements other than historical facts
are
statements that are or could be deemed forward-looking statements, including,
without limitation any future results of operations, plans or strategies
or
relating to future economic or industry conditions. Factors that might cause
such differences include, but are not limited to, those discussed in the
subsection entitled “Risk Factors” under Part I, page 8 or that are otherwise
described from time to time in our reports filed with the Securities and
Exchange Commission after this Annual Report. PGMI assumes no obligation
to
update any forward looking statements to reflect events that occur or
circumstances that may arise after the date as of which they are
made.
The
Company; Corporate History
PGMI,
Inc. (the “Company”) was organized under the laws of the State of Utah on May 9,
1972 under the name of High-Line Investment & Development Company. In
1977, we changed our name to Gayle Industries, Inc. In 1978, we merged
into Swing Bike. In 1979, we changed our name to Horizon Energy
Corporation. In 1992, we changed our name to Millennium Entertainment
Corp. In 1993, we changed our name to New Horizon Education, Inc. In
September 2002, we changed our name to American Hospital Resources, Inc.
In May 2005, in anticipation of acquiring HAPS USA, Inc., (a Delaware
corporation), a company which manages foreign casinos, we changed our name
to
HAPS USA, Inc. In August of 2005, the plans for the acquisition were
abandoned.
On
October 27, 2005, we entered into an Agreement and Plan of Reorganization
(the “Agreement”) with PGMI, Inc., a Delaware corporation (“PGMI”) and the
stockholders of PGMI, which provided for a tax-free share exchange under
Section 368(a)(1)(B) of the Internal Revenue Code. Such transaction
was accounted for as a reorganization. The share exchange closed on
December 9, 2005. Pursuant to the Agreement, all of the 10,000 shares of
outstanding common stock of PGMI were acquired in exchange for 97,059,998
shares
of our Class E Convertible Preferred Stock. Each share of
Class E convertible preferred stock is convertible, commencing on the date
which is 3 years following the closing date, into 5 shares of our common
stock. The outstanding shares of Class E Convertible Preferred Stock
represent approximately 91.5% of our outstanding voting power. We have a
wholly-owned subsidiary, Marugin International, Inc., a corporation formed
and existing under the laws of Japan. Our subsidiary is an operating
entity, which presently operates pachinko stores in Japan with in excess
of $23
million in gaming revenues and 1.6 million in net losses due to opening of
its
two largest stores during fiscal 2005.
At
the
time of acquisition, HAPS had no revenues and no significant assets or
liabilities. It was considered a blank-check company prior to the
acquisition. The acquisition of PGMI by HAPS will be accounted for as a
reverse acquisition, whereby the assets and liabilities of Exam are reported
at
their historical cost. The assets and liabilities of HAPS will be recorded
at fair value on December 9, 2005, the date of close. The effects of
stockholders’ equity will be reported as a recapitalization. No goodwill
will be recorded in connection with the reverse acquisition. The reverse
acquisition resulted in a change in reporting entity of HAPS for accounting
and
reporting purposes. Accordingly, the financial statements reported herein
have retroactively restated for all periods presented to report the historical
financial position, results of operations and of cash flows of PGMI. On March
15, 2006 we changed our name to PGMI, Inc.
At
various places in this report, we may make reference to “PGMI” or the “company”
or “us” or “we.” When we use those terms, unless the context otherwise
requires, we mean PGMI, Inc., a Utah Corporation and its operating subsidiary,
Marugin International, Inc.
We
are
traded on the NASD Over-the-Counter Bulletin Board under the ticker symbol
PGMI.OB.
1
Our
domestic headquarters are located in Huntington Beach, California. Our mailing
address is 5912 Bolsa Avenue, Suite 108, Huntington Beach, California 92649.
Our
telephone number is (714) 895-7772. Our Annual Report on Form 10-KSB,
quarterly reports on Form 10-QSB, current reports on Form 8-K, and all
amendments to those reports filed with or furnished to the SEC are available,
free of charge, through our website at www.pgmi-inc.com
as soon
as reasonably practicable after such reports are electronically filed with
or
furnished to the Securities and Exchange Commission.
Marugin
International
Marugin
International, Inc., (“Marugin”) was incorporated on December 22, 1972. On June
10, 2003, Marugin formed PGMI Delaware to effect a share exchange agreement,
whereby Marugin became a wholly-owned subsidiary of PGMI (collectively, the
“Company”). As of June 30, 2006, the Company operated a total of thirteen stores
which offer Pachinko (Japanese pinball) gaming entertainment. Twelve stores
are
located in the Nagano prefecture of Japan, and 2 stores are located in the
Ibaraki prefecture of Japan. Our 13 stores have a combined 4,290 machines.
In July 2004 and March 2005, we opened our 2 largest stores with 560 machines
each. The Company receives income from cigarettes, non-alcoholic beverages,
Aichi and sundry items, as well as one small batting cage and a bowling alley.
We
believe that our stores are strategically located in areas that are convenient
and accessible to local residents. Our stores are known by our customers
to be
clean, attractive and comfortable. Our growth has been driven by the successful
addition of new stores and enhancements to the operational efficiency of
existing locations. We are led by a seasoned executive management team with
decades of experience and accumulated industry knowledge.
PGMI’s
Existing Pachinko Store Statistics
|
· Average
gross wagers per sq. m: $20,696
· Average
gross wagers per machine: $42,651
· Average
number of machines per store: 330 machines
· Average
annual revenue per machine: $5,290
· Average
age of each store: 19 years
· Average
number of employes per store: 14
|
The
Industry
Introduction
to Pachinko
Pachinko
is
believed to have originated in Japan in the 1920s based on a vertical
pinball-like device called the Corinthian Game that was imported into Japan
from
the U.S. Pachinko is a game in which players shoot steel metal balls about
3/8”
in diameter into a vertical machine that resembles a Western slot machine.
The
machine features pins that guide the direction of the balls into one of several
slots in the machine. Certain slots release more balls while other slots
capture
the ball. The machines also have an automatic ball feeder that allows the
player
to quickly release balls into the machine. The player uses a round knob at
the
bottom of the machine, thereby adding an element of skill to the game, to
control the speed and force of the balls as they are released into the machine.
Pachinko machines today also feature digital displays in the background that
resemble slot machines. The digital display is activated when the balls touch
certain areas within the machine and allow the player to win extra balls.
Upon
completion of play, patrons can exchange balls for prizes, such as cigarettes,
candy, and other merchandise, or a ‘special prize’ which can be exchanged for
money.
Pachislo
machines,
similar to Western slot machines, are also typically found in pachinko stores.
The key difference between a pachislo machine and a Western slot machine
is that
the player controls when each individual reel stops, thereby requiring a
certain
degree of skill as well as chance. Another difference is that pachislo machines
do not offer the big “jackpot” payouts paid by Western slot machines. Similar to
the machine’s low token retention (“hold”) rate, payouts are also kept modest,
to conform to Japan’s strict regulations regarding speculative entertainment
activities.
2
The
Gaming Experience
A
customer entering a modern Japanese electronic gaming store who wishes to
play
Pachinko or Pachislo would either approach a machine and insert cash directly
into a computer monitored bill reader or purchase a prepaid magnetic card
from
one of several vending machines located around the gaming floor which is
then
inserted into the machine’s reader. In either instance the machine dispenses a
specified number of balls into the machine’s loading tray or payout tray at a
posted price per ball. The player then plays the game and, if successful,
collects his or her winnings in plastic bins provided by the store by manually
releasing a trap at the base of the machine’s collection tray. When he or she is
finished gaming, the customer transfers the filled bins to ball or token
counting machines which automatically supply the customer with a magnetic
or
paper receipt for the number of balls or tokens collected. The customer then
presents the receipt at the redemption counter which offers the customer
a
choice of credit towards retail goods sold by the store or a ‘special prize’
that can be sold for money at a special prize exchange station located within
close proximity to the pachinko store (see “The
Tri-Party Transaction”
below).
Ball/Token
Redemption
The
redemption price of balls or tokens is at a lower price per ball/token than
the
buy-in price. On average, the buy-in price for pachinko balls is 4 yen per
ball
while the redemption rate ranges from 2.75 to 3.75 yen per ball among some
of
our main competitors. Our redemption rate ranges from 2.5 to 4.0 yen per
ball
for our stores. Our competitors’ rates allow their stores to profit while giving
their players a typical payout ratio of between 120% and 130%, which gives
the
player the feeling that he or she has had a winning session. As a result,
the
store’s net revenues on total gross wagers are determined by a combination of
the hold
percentages
set on
the machines and the ball/token redemption
ratio.
As in
Western style casinos, a “looser” machine (one with a lower hold percentage)
will increase the amount of time that a player will play without losing all
of
his or her investment, and result in a lower player velocity for the casino.
In
order to remain profitable under such a scenario, the store must modify its
ball/token redemption ratio to offset the low hold percentage on the machines.
Smaller stores typically employ this business model. In contrast, better
established, dominant properties with significant customer traffic offer
the
player higher redemption rates on “tighter” machines (higher hold percentages).
Under this configuration, player velocity is increased as players either
lose
more quickly or increase their level of wagers in order to fill the same
amount
of playing time. Adjusting this all-important mix correctly is of critical
importance in maximizing profitability and is the hallmark of an experienced
operator. The advancements in IT infrastructure for pachinko operations allow
pachinko operators to monitor the profitability of each machine in accurate
detail and in real-time.
While
balls and tokens can be redeemed for various prizes such as candy, cigarettes,
consumer electronics and certain luxury items, the vast majority of the
redemptions are for a ‘special prize’. The concept of the ‘special prize’ has
existed for decades in the Pachinko business, although in later years it
has
become significantly more refined. Under Japanese law it is not permissible
to
exchange pachinko balls or slot machine tokens for currency, gold, or
securities. As a result, the Japanese pachinko industry has established the
tri-party
transaction
system
whereby customers can exchange balls/tokens for certain objects of nominal
value
which acts as a mode of exchange between the store, the customer, and a
completely unrelated business entity that will accept the object from the
customer in exchange for cash.
The
Tri-Party Transaction
The
3
parties involved in the tri-party transaction are (i) the casino/store, (ii)
the
prize buyer (“Kaitori-Gyosha”), and (iii) the prize wholesaler (“Nonyu-Gyosha”).
Each of the parties must be completely unrelated to the others, both legally
and
economically, in order to avoid a violation of the law.
3
Diagram
of the Tri-Party Transaction
Each
pachinko store maintains an arms-length ad hoc relationship with a prize
wholesaler, pursuant to which the prize wholesaler agrees to cause the ‘special
prizes’ to be manufactured and sold to the store and the store agrees to
purchase ‘special prizes’ from the prize wholesaler each day in order to
maintain sufficient inventory. The prize wholesaler and buyer have a similar
ad
hoc relationship to which the store is not a party. The third component of
the
tri-party transaction is the relationship between the store customer and
the
prize buyer. The buyer maintains a freestanding or leased facility nearby
the
store consisting of a manned window. A customer possessing ‘special prizes’ will
exit the store and exchange them for a like amount of cash at the prize buyer’s
window.
All
receipts from the store are removed daily from the prepaid card vending machines
and pachinko/pachislo machines and deposited, either directly on a normal
business day or by lock-box if banks are closed, at the store’s bank. At the
opening of each business day, the store wires from its account to the account
of
the prize wholesaler, an amount roughly aggregating the value of the ‘special
prizes’ that the wholesaler has acquired from the prize buyer representing trade
during the previous day plus a commission. The wholesaler uses the proceeds
to
purchase the ‘special prizes’ from the buyer, also with a commission agreement.
Thus the special prizes make the triangular, and legally permissible trip
from
the store, to the prize buyer, to the wholesaler, who then sells an inventory
of
special prizes back to the store.
The
tri-party transaction is explicitly designed and regulated to be in compliance
with Japan’s
Law
Concerning Regulation of Businesses Affecting Public Morals.
Insofar
as the store operator has no contractual relationship with the prize buyer,
and
is economically and legally indifferent to the buyer’s business activities, the
store operator is effectively removed from two of the three prize exchange
transactions and the store operator is involved only in the purchase of special
prize inventory from the prize wholesaler. Thus, given the form of the prize
exchange system and assuming the independence of the three parties, as both
a
legal and economic matter, the tri-party transaction has been designed by
the
industry and the regulators specifically to preclude a violation of the
law.
4
The
Japanese Pachinko Industry
Pachinko,
along with public lotteries and horse, motorboat, and cycle racing, is one
of
the key segments of the Japanese gaming industry. Pachinko and its variants,
including pachislo, account for more than two-thirds of total wager volume
in
Japan. Generating an estimated $277 billion in gross wagers per annum and
employing over 319,000 employees, the Japanese pachinko industry is larger
than
even the country’s automobile industry, and is, by far, the largest service
industry sector in Japan. Pachinko is the most popular source of leisure
and
entertainment, (including dining), in Japan and a regular component of the
Japanese lifestyle. In a country with a population of 127 million, an estimated
40 to 50 million Japanese play pachinko while an estimated 25 million people
play on a regular basis. While pachinko was traditionally played primarily
by
males of legal gambling age (18 and over), pachinko has grown to appeal to
Japanese women as well. To cater to the significant number of female players,
many stores now feature refrigerators in which housewives can temporarily
place
their purchased groceries while they play and feature prizes, like brand-name
purses, that appeal to women.
Some
key
statistics pertaining to the Japanese pachinko industry are listed
below:
|
·
|
A
total of approximately 6,100 operators operate approximately 16,100
stores
housing an estimated 4.9 million pachinko and pachislo machines.
The
industry generates annual gross wagers of approximately $277 billion,
or
an average of $17.2 million per store. (Source: Tokyo-based
Yano Research Institute, Ltd.)
|
|
·
|
The
industry employs an estimated 319,000 people compared to 350,000
employed
by the entire U.S. casino industry. (Source: Tokyo-based
Yano Research Institute, Ltd.)
|
|
·
|
Approximately
26% of adults (approximately 25 million people) in Japan are regular
customers of the Japanese electronic gaming industry. (Source:
The
Leisure and Development Center)
|
|
·
|
The
Japanese pachinko industry represents over one-third of all spending
on
entertainment making it one of the largest in international gaming
markets
and one of the largest sectors of the Japanese economy. (Source:
Japanese
Ministry of Economy, Trade and Industry)
|
|
·
|
Pachinko
is enjoyed by a growing number of women, who currently represent
over 20%
of all players. On average, women frequent pachinko stores three
times a
week and spend 29,000 yen per visit, about 2,000 yen more than
men.
(Source: Tokyo-based
Yano Research Institute Ltd.)
|
Due
to
the importance of pachinko to Japan’s economy both as a source of employment for
over 319,000 people and a significant contributor to the country’s annual tax
revenues, the government of Japan has made a conscious effort to establish
and
enforce laws to protect consumers, rid criminal elements and raise the public
image of the pachinko industry.
Another
characteristic of the Japanese pachinko industry that makes its attractive
to
both operators and investors is its relative imperviousness to economic trends.
In fact, pachinko stores have actually been known to perform better during
economic recessions as individuals seek ways to supplement their
incomes.
5
Further evidence
of the magnitude of the Japanese pachinko industry are the leading Japanese
pachinko/pachislo machine manufacturers, including Sankyo Co., Sammy
Corporation, Heiwa Corporation, Sigma Gaming, and Konami Co., who have grown
to
become some of the largest publicly listed companies in Japan.
Pachinko
Operator Landscape
The
Japanese pachinko industry is highly fragmented, with an estimated 6,100
operators and 16,100 stores housing an aggregate 4.9 million pachinko and
pachislo machines throughout the country. The largest operator is Dynam Co.,
Ltd., which has approximately 240 stores throughout Japan, with the next
largest
operator being Maruhan Co., Ltd., which has approximately 165 stores. Smaller
stores average 100 to 200 machines while larger stores, such two (2) of the
stores belonging to PGMI, have 500 or more machines. The pachinko industry
has
been revolutionized over the last several years with enhancements to pachinko
and pachislo machines and information technology that allow operators to
capture
comprehensive, real-time data on the performance and usage of each individual
machine. Pachinko machines have largely been converted to a digital format
that
features a digital slot machine-like screen in the background that enhances
the
playing experience and winnings potential for the customer. These enhancements
to machines and IT infrastructure have increased the capital expenditures
required to establish and maintain a modern pachinko facility. As a result,
the
yet highly fragmented pachinko industry is experiencing a consolidation trend
as
smaller stores, who lack the financial resources to make such enhancements,
are
being put out of business by larger competitors, such as PGMI with greater
financial, staff and other necessary resources and operational
experience.
Regulatory
Matters
The
criminal law of Japan essentially prohibits gambling organized by private
entities. However, pachinko is considered part of the leisure industry, which
is
exempt from the prohibition against gambling. Pachinko is regulated by the
Japanese National Police Agency (“NPA”), through the prefectural police
departments, which has taken the stance that pachinko is not gambling but
simply
a “reasonably speculative form of pastime.” Pachinko regulations fall under the
Entertainment
Establishment Control Law
and the
ministerial ordinances and regulations thereunder. Customers must be at least
18
years of age. Pachinko stores are open seven (7) days a week; however, they
are
not permitted to operate between the hours of 11 p.m. and 9 a.m. Also, customers
are forbidden from taking pachinko balls from the stores and therefore ‘rent’
the balls with which they play.
Most
important of the regulations is the law forbidding pachinko stores from giving
cash or securities as a prize or repurchasing prizes for cash or securities.
In
addition, there exist a number of other regulations such as requirements
regarding qualifications to obtain pachinko store operating licenses, machine
designs and payout ratios and regulations pertaining to the pachinko store
facilities themselves. Although law in Japan prohibits casino gambling, a
statutory system of laws has been established that allows pachinko operators
to
provide gaming services to its customers. (See “The
Tri-party Transaction”
above.)
In
previous years, questionable business practices, tax evasion, and crime
associated with the electronic gaming industry gave the industry a negative
public image. However, over the last fifteen years, the growing magnitude
and
importance of pachinko to the Japanese economy spurred the government and
industry associations to step in to establish strict regulations, remove
criminal elements and improve the public image of the pachinko industry.
The
regulation effort has been highly successful and has been of one the principal
catalysts for the growth of large operators in the industry as well as the
involvement of major companies from such traditional industries as trading,
supermarkets and railroads. In addition, foreign corporations and investors
have
taken interest in Japanese pachinko operations due to the profitability and
financial stability of their operations. For instance, in 2001, BS Group,
a UK
corporation, purchased a stake in leading pachinko operator, Tokyo Plaza,
who
runs about 20 stores in Japan, and established its own pachinko stores in
the
United Kingdom. Due to the success of these reform efforts during the last
two
decades, the Japanese pachinko industry has evolved to become an integral
part
of the entertainment sector of the Japanese economy and an important contributor
to the Japanese economy.
6
Police
involvement is especially important in the tri-party transaction system of
the
Japanese pachinko industry. To better regulate pachinko operators and provide
greater protection from criminal influences, many police union retirees have
been hired to work in the prize buying and wholesaling operations. Due to
the
importance of regulating this critical aspect of the Japanese electronic
gaming
industry as well as the significance of the commission income from these
operations to economic well-being of such police retirees, the NPA issued
a
report in October 1994 officially endorsing the existing prize exchange
mechanism and required that a portion of the proceeds from such systems be
dedicated to social welfare programs.
Regulatory
Bodies Overseeing the Japanese Pachinko Industry
|
Regulatory
Body
|
Regulatory
Function performed
|
|
National
Public Safety Commission (NPSC)&
Prefectural
Governments
|
Granting
licenses and permits required to operate pachinko stores
|
|
The
NPSC regulations contain technical standards for pachinko games.
These
standards describe attributes of a pachinko game that are deemed
to stir
up the gambling spirit. Thus, they define the outer limits for how
pachinko machines may legally operate.
|
|
|
Supervises
the National Police Agency (NPA) which implements the policies set
by the
NPSC and oversees the prefectural police agencies
|
|
|
Prefectural
Public Safety Commission
(PSC)
|
Hearing
disciplinary actions against licensees and taking action against
the
licensees by revoking the license or suspending the pachinko license
for
up to six months
|
|
Investigating
the suitability of applicants for pachinko licenses or other permits
that
may be required for a person or business entity to be associated
with the
pachinko industry
|
|
|
Local
(prefectural) police are included in the PSC and are responsible
for
enforcing the laws related to pachinko operations
|
|
|
Prefectural
Police & Metropolitan Police Department
(MPD)
|
Enforcement
of the pachinko operating laws and regulations through observation
and
investigation
|
|
NPSC
& Security
Electronics
and Communications
Technology
Association (SECTA)
|
Examination
and approval of electronic gaming devices
|
|
Ministry
of Justice
Law
Department in MPD
|
Legal
advice and services.
|
Our
Employees and Consultants
As
of June 30, 2006, we had 104 full-time employees and
120 part-time
employees. Our employees are not represented by a collective bargaining
organization.
We believe our relationship with our employees is good.
7
Risk
Factors
Our
industry is subject to intense competition from a number of other store
operators.
There
are a total of approximately 16,100 pachinko stores in Japan, which are run
by
approximately 6,100 operators.
We have
several established competitors in each of our current and target geographic
markets. Some of these competitors have comparable or greater financial and
other resources than we do and, therefore, they may be able better attract
customers by updating their stores and pachinko machines, and through increased
marketing efforts.
Changes
in the government regulations pertaining to the gaming and pachinko industries
could adversely affect our business.
The
Japanese pachinko industry is regulated by a system of laws created and enforced
by various national and prefectural government entities. Although casino
gambling is legally forbidden in Japan, pachinko has been designated as a
non-gambling form of adult entertainment. The tri-party exchange system,
established as an indirect mechanism for providing cash prizes without
transgressing anti-gambling regulations, is permitted but highly regulated.
However, changing government regulations regarding the definition of pachinko
as
a ‘non-gambling’ activity and/or restrictions regarding the indirect awarding of
cash or similar prizes may have a significant impact on pachinko operators
in
continuing normal business operations.
We
may not be able to obtain the capital required for us to maintain our existing
facilities and achieve our expansion goals.
Our
expansion plans to open additional stores will require substantial capital
commitments and outlays to acquire land rights, construct new buildings,
purchase machines and related equipment, hire operational personnel and procure
other resources associated with establishing new pachinko stores. We have
received most of our financing to date from paid in capital from founders and
existing shareholders, bank loans and cash flow from the operation of our
existing business. As we expand, our capital requirements will increase. If
for
any reason we are unable to meet ours capital requirements, we will be unable
to
attain our expansion plans, which could adversely affect or ability to compete
and our financial results.
We
need to enhance our internal controls in order in ensure the accuracy of our
financial reporting.
Our
auditors have advised us of certain significant internal control deficiencies
that they consider to be, in the aggregate, a material weakness, including,
inadequate staffing and supervision leading to the untimely identification
and
resolution of certain accounting matters; failure to perform timely reviews,
substantiation and evaluation of certain general ledger account balances; lack
of procedures or expertise needed to prepare all required disclosures; and
evidence that employees lack the qualifications and training to fulfill their
assigned functions. Our auditors indicated that they considered these
deficiencies to be a material weakness as that term is defined under standards
established by the American Institute of Certified Public Accountants. We
considered these matters in connection with the year-end closing of accounts
and
preparation of financial statements as and for the year ended June 30, 2006
and
determined that such matters did not materially affect any prior period
financial statements.
In
response to the observations made by our auditors we will proceed more
expeditiously with our existing plan to enhance our internal controls and
procedures, which we believe addresses each of the matters raised by our
auditors.
We
enhanced our internal control procedures by adding a part-time dedicated Chief
Accounting Officer (“CAO”) to our principal executive offices in Huntington
Beach, California. We are evaluating the need to supplement our CAO with
additional assistance. Our CAO is responsible for preparing a disclosure control
and reporting package. We need to establish a written policies and procedures
manual over internal controls of accounting and financial reporting. We also
need to incorporate preparation of an annual budget and report budget-to-actual
analyses on an annual and quarterly basis.
8
We
have a working capital deficit and successive years of losses which raises
doubts about our ability to continue as a going
concern.
At
June
30, 2006 we had a working capital deficit of approximately $500,000 and
commitments to fund new store expansion. In addition, we have incurred net
losses in each of our last two fiscal years. The report of our Independent
Registered Public Accountants for the year ended June 30, 2006, includes an
explanatory paragraph to their audit opinion stating that our working capital
deficiency raises substantial doubt about our ability to continue as a going
concern. While management has implemented a series of cost reduction measures
to
reduce costs, there can be no assurance that our plans will be sufficient to
enable us to sustain our operations without raising additional debt or equity
financing, which we may not be able to do on terms favorable to us or at
all.
An
active trading market may not develop for our common stock, which makes it
difficult for shareholders to sell their shares of our
stock.
Our
shares of common stock are publicly quoted on NASD over-the-counter bulletin
board system. Securities listed on the OTC bulletin board generally have less
trading volume and institutional market support and therefore may be susceptible
to greater fluctuations in price and have a lower degree of liquidity than
shares listed on a larger exchange, such as the NASDAQ or NYSE. Ownership of
our
common stock is highly concentrated and the daily trading volume does not yet
provide significant liquidity. Trading may be difficult due to the limited
public float, narrow base of shareholders and the lack of an institutional
market maker to provide liquidity and pricing support for the Company’s
stock.
Our
common stock is subject to penny stock regulation, which may affect its
liquidity.
Our
common stock is subject to regulations of the Securities and Exchange Commission
(the “Commission”) relating to the market for penny stocks. Penny stock, as
defined by the Penny Stock Reform Act, is any equity security not traded on
a
national securities exchange that has a market price of less than $5.00 per
share. The penny stock regulations generally require that a disclosure schedule
explaining the penny stock market and the risks associated therewith be
delivered to purchasers of penny stocks and impose various sales practice
requirements on broker-dealers who sell penny stocks to persons other than
established customers and accredited investors. The broker-dealer must make
a
suitability determination for each purchaser and receive the purchaser’s written
agreement prior to the sale. In addition, the broker-dealer must make certain
mandated disclosures, including the actual sale or purchase price and actual
bid
offer quotations, as well as the compensation to be received by the
broker-dealer and certain associated persons. The regulations applicable to
penny stocks may severely affect the market liquidity for our common stock
and
could limit your ability to sell your securities in the secondary
market.
Our
common stock may experience extreme price and volume
fluctuations.
Due
to
the limited trading volume and public float, the concentration of share
ownership, and the lack of market makers in the Company’s stock, attempts to buy
or sell a substantial number of shares could result in significant market price
fluctuations.
Our
management controls a substantial percentage of our outstanding voting
securities.
Our
management, together with family members, control approximately 91.5% of the
outstanding voting control of our company. Consequently, it would be almost
impossible for a third party to obtain control of our company, or influence
our
day-to-day operations.
9
We
do not have a separate standing audit committee, compensation committee or
nominating and corporate governance committee, so the duties customarily
delegated to those committees are performed by the board of directors as a
whole, and no director is an “audit committee financial expert” as defined by
the rules and regulations of the Securities and Exchange
Commission.
Our
Board
of Directors consists of four members. The Board of Directors as a whole
performs the functions of an Audit Committee, Compensation Committee and
Nominating and Corporate Governance Committee. None of the directors is
considered “independent” under Rule 4200(a)(15) of the National Association
of Securities Dealers listing standards, and neither qualifies as an audit
committee financial expert as defined in Item 401 of Regulation S-B.
Accordingly, we will not be able to list our common stock with a nationally
recognized exchange until we recruit independent directors to the Board and
restructure our Board to comply with various requirements currently in place
by
those self-regulating organizations, and as a result, it may be difficult for
you to sell our common stock.
The
requirements of the Sarbanes-Oxley Act, including section 404, are
burdensome, and our failure to comply with them could have a material adverse
affect on our business and stock price.
Except
with respect to the adoption of our Code of Ethics and our compliance with
certain requirements specifically applicable to our Annual Report on
Form 10-KSB and our other periodic reports, our management has not
commenced any specific procedures to comply with the requirements of the
Sarbanes Oxley Act of 2002, including specifically, the process necessary to
implement the requirements of Section 404 of the Sarbanes-Oxley Act of
2002, which requires our management to assess the effectiveness of our internal
controls over financial reporting and include an assertion in our annual report
as to the effectiveness of our controls. Beginning with our Annual Report
on Form 10-KSB for the year ended June 30, 2008, unless otherwise amended
by the Securities and Exchange Commission, our independent registered accounting
firm will be required to attest to whether our assessment of the effectiveness
of our internal control over financial reporting is fairly stated in all
material respects and separately report on whether it believes we maintained,
in
all material respects, effective internal controls over financial reporting
as
of June 30, 2008. Because of our management’s lack of resources, and our
limited operations, we have not commenced the process of preparing the system
and process documentation, performing an evaluation of our internal controls
required for our management to make this assessment and for the auditors to
provide their attestation report, and accordingly, have not begun testing of
the
effectiveness of these internal controls. We expect that this process will
require significant amounts of management time and resources, as well as higher
expenses in the form of higher audit and review fees, higher legal fees and
higher internal costs to document, test and potentially remediate internal
controls. Accordingly, with respect to Section 404 in particular, there
exists a significant risk that we will not be able to meet all the requirements
of Section 404 by the end of fiscal year 2008, when we are required to
report on our internal controls and provide our auditor’s opinion thereon.
Additionally, even in the event we attempt to comply with Section 404, in
the course of evaluation and testing, management may identify deficiencies
that
will need to be addressed and remediated, which could potentially have a
material adverse effect on our stock price and could result in significant
additional expenditures.
10
We
sublease approximately 500 square feet in Huntington Beach, California, for
our
domestic executive offices. The lease requires monthly rental payments of
$2,000, and has a term that expires on June 30, 2007. Subject to the
sublessor’s ability to keep the underlying lease in effect, we have an option
for an additional year at a price to be mutually agreed upon. Our
sublessor under this lease is a corporation that is controlled by Mr. Haruo
Miyano, a director of our Delaware subsidiary, PGMI, Inc.
With
respect to our Pachinko stores, we lease the land at 4 of the locations
upon which we constructed our stores. We incurred the costs of the
buildings and improvements constructed on these 4 locations. We also
leases land at 6 other locations for store parking lots. With
regard to all of the foregoing leases, the individual minimum monthly rental
payments under these leases range from $22 to $30,712 per month, and the
aggregate total monthly payment is $79,110 per month. Under Japanese
custom, if significant improvements are made to the leased land, the land leases
are required to be extended by the lessor for as long as we are in
operation. We have made significant modifications to the land through
construction of buildings and parking lots. Thus, the terms of the land
leases in most cases are continuous. We lease certain land from two of our
officers. The combined monthly lease payments to the officers are $7,200,
and the contracts expire on April 30, 2007 and June 30,
2008.
The
land
that we own, together with all of our buildings, serve as collateral for
multiple loans and notes payable to various commercial banks. As of
June 30, 2006 the aggregate outstanding principal balance of the loans and
notes was approximately $21,745,000. The loans and notes bear interest at
per annum rates ranging from 2.3% to 4.00%, and mature at various dates through
2014.
We
are
not currently a party to any legal proceedings.
None.
11
PART
II
Market
Price
Our
common stock is traded on the NASD Electronic Bulletin Board over-the-counter
market, and is quoted under the symbol PGMI. The table below gives the range
of
high and low bid prices of our common stock for the fiscal years ended June
30,
2006 and June 30, 2005 based on information provided by the OTC Bulletin Board.
Such over-the-counter market quotations reflect inter-dealer prices, without
mark-up, mark-down or commissions and may not necessarily represent actual
transactions or a liquid trading market.
|
June
30, 2006:
|
High
|
Low
|
|
1st
Quarter
|
$0.51
|
$0.12
|
|
2nd
Quarter
|
$0.51
|
$0.17
|
|
3rd
Quarter
|
$0.64
|
$0.17
|
|
4th
Quarter
|
$0.53
|
$0.21
|
|
|
|
|
|
June
30, 2005:
|
High
|
Low
|
|
1st
Quarter
|
$0.26
|
$0.16
|
|
2nd
Quarter
|
$0.68
|
$0.17
|
|
3rd
Quarter
|
$1.15
|
$0.32
|
|
4th
Quarter
|
$0.80
|
$0.35
|
When
the
trading price of our common stock is below $5.00 per share, our common stock
is
considered to be “penny stocks” that are subject to rules promulgated by the
Securities and Exchange Commission (Rule 15-1 through 15g-9) under the
Securities Exchange Act of 1934. These rules impose significant requirements
on
brokers under these circumstances, including: (a) delivering to customers the
Commission’s standardized risk disclosure document; (b) providing customers with
current bid and ask prices; (c) disclosing to customers the brokers-dealer’s and
sales representatives compensation; and (d) providing to customers monthly
account statements.
The
number of shareholders of record of our common stock as of September 15, 2006
was 607.
Description
of Securities
The
Company is presently authorized under its Certificate of Incorporation to issue
750,000,000 shares of common stock, no par value per share, and 150,000,000
shares of preferred stock, no par value per share. As of September 15, 2006,
the
Company had 25,003,671 shares of common stock issued and outstanding, held
by
607 stockholders of record. The holders of Common Stock are entitled to one
vote
for each share held of record on all matters submitted to a vote of the holders
of Common Stock. Subject to preferences applicable to any outstanding Preferred
Stock, holders of Common Stock are entitled to receive ratably such dividends
as
may be declared by the Board of Directors out of funds legally available
therefore. In the event of a liquidation, dissolution or winding up of the
Company, the holders of Common Stock are entitled to share ratably all assets
remaining after payment of liabilities and the liquidation preference of any
Preferred Stock. Holders of Common Stock have no preemptive or subscription
rights, and there are no redemption or conversion rights with respect to such
shares. All outstanding shares of Common Stock are fully paid and
non-assessable.
Our
board
of directors has the authority, without further action by the stockholders,
to
issue up to 150,000,000 shares of preferred stock in one or more series and
to
fix the rights, preferences, privileges and restrictions of these shares of
preferred stock without any further vote or action by stockholders. These rights
and preferences include dividend rights, conversion rights, voting rights,
terms
of redemption, liquidation preferences, sinking fund terms and the number of
shares constituting any series or the designation of the series. The issuance
of
preferred stock could adversely affect the voting power of holders of common
stock and the likelihood that the holders will receive dividend payments and
payments upon liquidation and could have the effect of delaying, deferring
or
preventing a change in control. At September 15, 2006, we had designated four
classes of preferred stock as follows: 6,000,000 shares designated as Class
A
convertible preferred stock, with 4,425,285 shares issued, or committed to
be issued, and outstanding; 5,000,000 shares designated as Class B
convertible preferred stock, with no shares issued and outstanding; 1,200,000
shares designated as Class C convertible preferred stock, with no shares issued
and outstanding; and 116,595,760 shares designated Class E convertible preferred
stock, with 97,059,998 shares issued and outstanding. Each outstanding share
of
preferred stock (Classes A and E) is entitled to 5 votes per share and is
convertible into 5 shares of common stock; provided, however, that the shares
of
Class E convertible preferred stock may not be converted until the date which
is
three years after their initial issuance, or December 9, 2008.
12
Options
We
have
no outstanding options to purchase shares of our common stock.
Registrar
and Transfer Agent
Our
registrar and transfer agent is Stalt, Inc., 671 Oak Grove Avenue, Suite C,
Menlo Park, California 94075; telephone (650) 321-7111.
Dividend
Policy
We
have
not adopted any policy regarding the payment of dividends on our common stock.
We do not intend to pay any cash dividends on our common stock in the
foreseeable future. We intend to invest all of our cash resources in developing
our business.
Recent
Sales of Unregistered Securities
None.
13
Overview
Through
our subsidiaries, we own and operate thirteen pachinko stores as of June
30,
2006. This is our primary operating business. We operate a total of 4,290
Pachinko and Pachislot machines. We are constructing two new stores (Bando
and
Gyoda) which will be opened in October and December 2006. We expect to have
about 600 Pachinko and Pachislot machines for each of these two new stores.
Estimated total costs at completion for Bando and Gyoda are approximately
$8,650,000 and $9,360,000, respectively. Construction costs incurred during
the
year ended June 30, 2006 for both stores in the amount of $3,790,000 were
included in land and construction in progress. In addition to the two new
stores
which commenced their construction process, we are also planning three stores
to
be opened in 2007. These three stores are expected to operate about 700 to
800
Pachinko and Pachislot machines each. During the year ended June 30, 2006,
the
Company has incurred for these three sites $1,120,000, which is included
in
construction in progress. We plan to leverage our expertise and capitalize
on
new development opportunities to expand our operations in Japan.
Cyclical
Nature of Business
The
Company’s primary business involves gaming entertainment. During periods of
recession or economic downturn, consumers may reduce or eliminate spending
on
gaming entertainment activities. In the event that any of the Company’s
demographic markets suffer adverse economic conditions, the Company’s revenues
may be materially adversely affected. In addition, the operations of the
pachinko stores are typically seasonal in nature. The sales during the
holiday
seasons are higher than the regular months. The biggest holiday season
in Japan
lies in the end of December through the beginning of January. Additionally,
revenues can fluctuate when a new type of pachinko machine is introduced
at the
stores.
Results
of Operations
Year
Ended June 30, 2006 Compared to Year Ended June 30, 2005
Operating
Revenues and Costs
A
summary
of the gaming revenues for the years ended June 30, 2006 and 2005 are as
follows:
|
2006
|
2005
|
|||
|
Amount
|
Percentage
|
Amount
|
Percentage
|
|
|
Patron
wagers (pay-ins)
|
$
187,972,786
|
100.0%
|
$
187,877,668
|
100.0%
|
|
Patron
payouts
|
(165,276,608)
|
(87.9)
|
(166,343,692)
|
(88.5)
|
|
Gaming
revenues
|
$
22,696,178
|
12.1%
|
$
21,533,976
|
11.5%
|
Consistent
with the gaming industry, we report our revenues as the net of wagers less
payouts. During the year, our gaming revenues increased from $21,533,976
in 2005
to $22,696,178 in 2006, an increase of 5.4 %.
Our
gross
wagers increased by $95,118 or 0.05% from the year ending June 30, 2005 to
$187,972,786 in the year ending June 30, 2006. The new store that opened
in
March 2005 contributed $28,892,726 to the increase in wagers. Four stores
increased their gross wagers to a total of $29,541,223 for the year ended
June
30, 2006, while nine stores decreased their gross wagers to
$15,819,076.
Our
payouts decreased by $1,067,084 or 0.6% from the year ending June 30, 2005
to
$165,276,608 in the year ending June 30, 2006. Our payouts as a percentage
of
wagers slightly decreased from 88.5% in 2005 to 87.9% in 2006 due to a high
payout rate campaign to promote the grand opening of two new stores in the
year
ended June 30, 2005, while no stores opened in the year ended June 30,
2006.
Cost
of Revenues
Costs
of
revenues as a percentage of total revenues for the year ended June 30, 2006
and
2005 are as follows:
|
2006
|
2005
|
||||||
|
Depreciation
|
32.2
|
%
|
32.4
|
%
|
|||
|
Salaries
& Wages
|
19.6
|
%
|
21.6
|
%
|
|||
|
Facilities
& other
|
19.8
|
%
|
23.9
|
%
|
|||
|
Impairment
of property and equipment
|
4.5
|
%
|
12.4
|
%
|
|||
|
Total
cost of revenues
|
76.1
|
%
|
90.3
|
%
|
|||
Cost
of
revenues for the year ended June 30, 2006 decreased by $2,327,065 or 11.1%
from
$20,975,811 to $18,648,746 compared to the year ended June 30, 2005. As a
percentage of revenues, our costs in the year ended June 30, 2006 decreased
to
76.1% from 90.3% for the year ended June 30, 2005. The large contributors
to
this decrease are the facility and impairment cost in the year ended June
30,
2005, which included costs related to the opening of the new store in March
2005. Depreciation expense is accelerated in the year of acquisition for
machines acquired. In addition, we provided impairments for machines which
were
removed from service prior to the end of their useful lives. Machine lives
are
generally two to three years, depending on technologies, playing habits and
customer preference. We are experiencing high turnover of our machines because
of player desires.
14
Marketing
and Advertising Expense
Marketing
and advertising expenses decreased by $161,103 from $1,086,925 for the year
ended June 30, 2005 to $925,822 for the year ended June 30, 2006. The decrease
is attributable to wide advertisement of the grand opening of the new stores
that opened in July 2006 and March 2006, which occurred in the year ended
June
30, 2005, while no stores opened in the year ended June 30, 2006. As a
percentage of revenues, we spent 3.8 % and 4.7 %, in the year ended June
30,
2006 and 2005.
General
and Administrative Expenses
General
and administrative expenses for the year ended June 30, 2006 increased by
$261,545 or 9.0% to $3,173,540 from $2,911,995 for the year ended June 30,
2005.
General and administrative expenses for the year ended June 30, 2006 constituted
13.0% of revenues in comparison to 12.5% for the year ended June 30, 2005.
The
increase in general and administrative costs from the 2005 period can be
attributed primarily to charges for professional fees in the aggregate amount
of
$856,255 related to the reverse merger in 2006, compared to $360,667 in
2005.
Other
Income and Expenses
Interest
expense increased by $107,537 to $1,679,624 in the year ended June 30, 2006,
from $1,572,087 for the year ended June 30, 2005, an increase of 6.8%. The
increase of interest expense is attributable to the increase of long term
loans
and lease contracts to acquire improvements and equipments in new stores
opened
in the year ended June 30, 2005.
Income
Taxes
Provision
for income taxes increased by $1,508,132 for the year ended June 30, 2006,
from
$863,331 of tax benefit to $644,801 of income tax expense. The increase in
income tax expense was mainly attributable to the increased valuation allowance
in the amount of $1,300,000 to offset the tax benefit of the net operating
loss
incurred in the United States for the year ended June 30, 2006.
Net
loss
We
incurred a net loss for the year ended June 30, 2006 of $2,098,887 versus
net
loss of $1,625,313 for the year ended June 30, 2005. This increase in net
loss
can be attributed to approximately $2,333,000 of one time reverse acquisition
fees incurred during the year June 30, 2006 and increased income tax expense
in
the amount of $640,000 due to increased taxable income in the Japan
operations.
Fourth
Quarter Adjustment
During
the quarterly period ended March 31, 2006, the Company inadvertently wrote
off
the 441 pachinko machines that were in storage, which are to be used in
the new
stores expected to open in fiscal 2007. In addition, the Company
incorrectly reduced the carrying value of the pachinko machines through
a charge
to operations. These charges are deemed an error by management, not a change
in
estimate, and accordingly, a required restatement of previously reported
amounts. During the fourth quarter ended June 30, 2006, management reversed
the
amounts that incorrectly reduced the carrying value of pachinko machines
totaling $428,580.
Liquidity
and Sources of Capital
Cash
Flows
During
the years ended June 30, 2006 and 2005, we generated $9,218,927 and $5,164,878
respectively, of cash flows from operating activities. Our cash provided
by
operating activities in fiscal 2006 and 2005 included non-cash depreciation
and
impairment losses aggregating $9,072,272 and $10,737,480
respectively.
During
the years ended June 30, 2006 and 2005, we used cash of $11,562,618 and
$2,525,213 respectively on investing activities. During such periods, we
spent
approximately $10,764,844 and $8,309,660 respectively, for capital additions.
The 2006 expenditures included approximately $4,962,524
for
the construction of the new stores which will be opened during the fiscal
year
ending June 30, 2007.
During
the years ended June 30, 2006, we provided cash of $2,840,349 from financing
activities. During this period, we borrowed $12,404,435 from four banks,
and we
repaid debt totaling $7,644,432. We used funds for construction of new stores.
In fiscal 2005, we used cash in our financing activities in the amount of
$238,267. We borrowed $11,129,322 and repaid long-term debt of $9,963,608
during
the year ended June 30, 2005.
Liquidity
The
Company has incurred losses during the year ended June 30, 2006 totaling
approximately $2,099,000. The Company may continue to incur losses during
fiscal
2007 largely due to start-up costs to be incurred with the new store expansions.
At June 30, 2006, the Company has a working capital deficit of approximately
$539,000. Furthermore, the Company is in the process of its store expansion,
which it has remaining obligations under construction contracts of two new
stores totaling $7,850,000 as of June 30, 2006. The Company requires additional
capital lease, debt and/or equity financing of approximately $6,360,000 to
acquire equipment and machines, as well as provide working capital to fund
initial start-up costs associated with the two new store openings. These
factors
raise substantial doubt about the Company’s ability to continue as a going
concern.
We
have
good relations with our banks in Japan. We believe PGMI will continue its
growth
and generate positive cash flows from operations to fund its daily operations
and service its debt obligations. There are no assurances that we will be
successful in our plans. No adjustments have been made to the carrying value
of
assets or liabilities as a result of the uncertainty about obtaining cash
required to pay obligations as they come due. Our independent registered
public
accounting firm has included an explanatory paragraph in their report regarding
substantial doubt about our ability to continue as a going concern because
of
these matters as required by auditing standards generally accepted in the
United
States.
15
Our
level
of indebtedness presents other risks to investors, including the possibility
that we may be unable to generate cash sufficient enough to pay the principal
of
and interest on our indebtedness when due; and that we may not be able to
meet
tests and covenants of such debt agreements and achieve satisfactory resolution
of such non-compliance with the lenders. In such an event, the holders of
our
indebtedness may be able to declare all indebtedness owing to them to be
due and
payable immediately, and proceed against any collateral securing such
indebtedness. These actions could limit
our
ability to borrow additional funds and would likely have a material adverse
effect on our business and results of operations.
Critical
Accounting Policies
Our
significant accounting policies are included in Note 2 of our Consolidated
Financial Statements included elsewhere in this Report. These policies, along
with the underlying assumptions and judgments made by our management in their
application, have a significant impact on our consolidated financial
statements.
Going
Concern Consideration
The
Company’s financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
in the normal course of business. As of June 30, 2006, the Company has a
working
capital deficit totaling $539,093. Management believes the Company will continue
its growth and generate positive cash flows from operations to fund its daily
operations and service its remaining debt obligations. There are no assurances
that management will be successful in its plans. No adjustments have been
made
to the carrying value of assets or liabilities as a result of this
uncertainty.
Impairment
of Long-Lived Assets and Intangibles
We
review
the carrying value of our long-lived assets whenever events or changes in
circumstances indicate that such carrying values may not be recoverable
annually. Unforeseen events and changes in circumstances and market conditions
and material differences in estimates of future cash flows could negatively
affect the fair value of our assets and result in an impairment charge. Fair
value is the amount at which the asset could be bought or sold in a current
transaction between willing parties. Fair value can be estimated utilizing
a
number of techniques including quoted market prices, prices for comparable
assets, or other valuation processes involving estimates of cash flows,
multiples of earnings or revenues. For land impairments, we have used government
prefecture estimated fair values, which they use for assessing
taxes.
Income
Taxes
We
account for income taxes in accordance with Statement
of Financial Accounting Standards No. 109, Accounting for Income
Taxes
(SFAS
No. 109) which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences
between the bases used for financial reporting and income tax reporting of
recorded assets and liabilities. SFAS No. 109 also requires that deferred
tax assets be reduced by a valuation allowance if it is more likely than
not
that some portion or all of the deferred tax asset will not be realized.
We have
provided valuation allowances because we feel that certain deferred tax assets
generated in the United States will not be recovered through future
operations.
Interest
Rate Swap Agreements
Interest
rate swap agreements and the hedged items are such that the hedges are
considered effective against changes in the fair value of the debt due to
changes in the benchmark interest rates over their terms. As a result, the
shortcut method provided by SFAS No. 133, “Accounting for Derivative Instruments
and Hedging Activities,” as amended by SFAS No. 149, is applied and there is no
need to periodically reassess the effectiveness of the hedges during the
terms
of the swaps. Interest expense on the debt is adjusted to include net payments
made or received under the swap agreements. The fair value of the swaps is
carried as an asset or a liability in the consolidated balance sheet and
the
carrying value of the hedged debt is adjusted accordingly. The fair values
of
PGMI’s interest rate swaps are the estimated amounts it would receive or pay to
terminate the agreements as of the reporting date as determined by the bank.
As
of June 30, 2006, the fair value of the outstanding swaps liability was $
180,889.
16
ITEM
7.
FINANCIAL
STATEMENTS
The
consolidated financial statements of PGMI, Inc.,
for its fiscal year ended June 30, 2006 are provided with this form 10-KSB
and
are incorporated herein by reference.
On
February 14, 2006, the Board of Directors of the Company approved a change
in
its independent registered public accounting firm. The Board of Directors
approved the dismissal of Pritchett, Siler & Hardy, P.C. (“Pritchett”) as
PGMI’s independent registered public accounting firm and the selection of
McKennon, Wilson & Morgan, LLP as their replacement.
Pritchett’s
report on the financial statements of the Company for the last two fiscal years
ended December 31, 2004 and 2003 did not contain any adverse opinion or
disclaimer of opinion, nor was it qualified or modified as to audit scope,
procedure or accounting.
During
PGMI’s two most recent fiscal years ended December 31, 2004 and the subsequent
interim periods through February 13, 2006, there were no disagreements between
PGMI and Pritchett on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to Pritchett’s satisfaction, would have caused
them to make reference to the subject matter of the disagreement in connection
with its reports on PGMI’s financial statements for such years, and there were
no reportable events as described in Item 304(a)(1)(v) of Regulation
S-K.
In
addition, during PGMI’s two most recent fiscal years ended December 31, 2004 and
the subsequent interim periods through February 13, 2006, HAPS did not consult
with McKennon, Wilson & Morgan, LLP with respect to the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on PGMI’s financial
statements, or any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-K.
Our
principal executive officer and principal financial officer have evaluated
the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended) as of the end of the period covered by this
quarterly report on Form 10-QSB. Based on this evaluation, our principal
executive officer and principal financial officer concluded that these
disclosure controls and procedures need improvement to ensure that the
information required to be disclosed in our reports filed or submitted under
the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the requisite time periods.
In
connection with its review of the our consolidated financial statements for
the
year ended June 30, 2005, McKennon, Wilson & Morgan LLP, the Company’s
independent accountants, advised management of certain significant internal
control deficiencies that they considered to be, in the aggregate, a material
weakness, including, inadequate staffing and supervision leading to the untimely
identification and resolution of certain accounting matters; failure to perform
timely reviews, substantiation and evaluation of certain general ledger account
balances; lack of procedures or expertise needed to prepare all required
disclosures; and evidence that employees lack the qualifications and training
to
fulfill their assigned functions. McKennon, Wilson & Morgan LLP
indicated that they considered these deficiencies to be a material weakness
as
that term is defined under standards established by the American Institute
of
Certified Public Accountants. A material weakness is a significant
deficiency in one or more of the internal control components that alone or
in
the aggregate precludes our internal control from reducing to an appropriately
low level the risk that material misstatements in our financial statements
will
not be prevented or detected on a timely basis. We considered these matters
in
connection with the quarter-end closing of accounts and preparation of financial
statements as and for the year ended June 30, 2006 and determined that no prior
period financial statements were materially affected by such
matters.
In
response to the observations made by McKennon, Wilson & Morgan LLP, we will
proceed more expeditiously with our existing plan to enhance our internal
controls and procedures, which we believe addresses each of the matters raised
by, McKennon, Wilson & Morgan LLP.
17
PART
III
ITEM
9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Executive
Officers and Directors
Our
executive officers and directors are as follows:
|
Name
(1) (2)
|
|
Age
|
|
Position
|
|
Gakushin
Kanemoto
|
|
79
|
|
Chairman
of the Board, Chief Financial Officer and Director
|
|
Shinichi
Kanemoto
|
|
49
|
|
Chief
Executive Officer, President and Director
|
|
Eiichi
Kanemoto
|
|
47
|
|
Secretary
and Director
|
|
Mark
Buck
|
|
61
|
|
Director
|
(1)
We presently have no executive committee, nominating committee or audit
committee of the Board of Directors.
(2)
Our officers and directors hold office until their successors are elected
and
qualified, or until their death, resignation or removal.
18
The
background and principal occupations of each director and officer of
PGMI are as
follows:
Gakushin
Kanemoto. Gakushin
Kanemoto is the founder of our business in Japan, which he founded in
1951. In December 1971 he established Marugin Co., Ltd., which became
the operator of our stores. In June 2002, the name was changed to Marugin
International, Inc. Mr. Kanemoto currently serves as the
Chairman and Chief Financial Officer of Marugin. Mr. Gakushin
Kanemoto is the father of Shinichi Kanemoto and Eiichi Kanemoto. Effective
December 9, 2005, Mr. Gakushin Kanemoto became the Chairman of the Board,
Chief Financial Officer, and a member of the Board of Directors of
PGMI, Inc.
Shinichi
Kanemoto. Shinichi
Kanemoto is the son of Mr. Gakushin Kanemoto. He currently serves as
the President and Chief Executive Officer of Marugin, positions he has
held
since 1993. Mr. Kanemoto is also a member of the board of directors
of Marugin. Mr. Kanemoto originally joined Marugin in 1981, and was
promoted to a Director in 1990, prior to being appointed to his current
officer
positions. Effective December 9, 2005, Mr. Shinichi Kanemoto became the
President, Chief Executive Officer and a member of the Board of Directors
of
PGMI, Inc.
Eiichi
Kanemoto. Eiichi
Kanemoto is the son of Mr. Gakushin Kanemoto. He currently serves as
our Executive Director, a position he was appointed to in 1993.
Mr. Kanemoto is also a member of the board of directors of Marugin.
Mr. Kanemoto originally joined Marugin in 1984, and was promoted to a
Director in 1990, prior to being appointed to his current officer
position. Effective December 9, 2005, Mr. Eiichi Kanemoto became the
Secretary and a member of the Board of Directors of PGMI, Inc.
Mark
Buck.
Mr. Buck served as our President, Chief Executive Officer and Chief
Financial Officer from March 2002 until December 9, 2005, and has been
a member
of our Board of Directors since March 2002. Mr. Buck is also a
commercial real estate broker specializing in sales and leasing. He has
worked for Commercial Real Estate Services in Honolulu, Hawaii since
1986 as
Vice President of Marketing and Sales. Mr. Buck has been an owner and
partner in three small businesses that he later sold.
Until
further determination by the Board, the full Board of Directors will
undertake
the duties of the Audit Committee, Compensation Committee and Nominating
Committee of the Board of Directors.
Financial
Expert
The
Company has no audit committee financial expert, as defined under
Section 228.401, serving on its audit committee because it has no audit
committee and is not required to have an audit committee because it is
not a
listed security as defined in Section 240.10A-3.
Code
of Business Conduct and Ethics
Our
Board
of Directors has approved a Code of Business Conduct and Ethics, which
applies
to all of our employees, directors and officers, including our principal
executive officer, principal financial officer, principal accounting
officer and
controller. The Code of Business Conduct and Ethics addresses such topics
as protection and proper use of our assets, compliance with applicable
laws and
regulations, accuracy and preservation of records, accounting and financial
reporting, conflicts of interest and insider trading. The Code of Business
Conduct and Ethics is available free of charge to any shareholder who
sends a
request for a paper copy to PGMI, Inc., 5912 Bolsa Avenue, Suite 108,
Huntington Beach, California 92649.
Section
16 Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our
directors and executive officers, and persons who beneficially own more
than 10% of a registered class of
our equity securities, to file reports of beneficial
ownership and changes in beneficial ownership of our securities with the
SEC on Forms 3 (Initial Statement of Beneficial Ownership), 4 (Statement
of
Changes of Beneficial Ownership of Securities) and 5
(Annual Statement of Beneficial Ownership of Securities).
Directors, executive officers and beneficial owners of
more than 10% of our Common Stock are required by SEC regulations to
furnish us with copies of all Section 16(a) forms
that they file. Based solely on review of the copies of such
forms furnished to us, or written representations that no reports were
required, we believe that for the fiscal year ended June 30, 2006 beneficial
owners complied
with Section 16(a) filing requirements.
19
ITEM
10. EXECUTIVE COMPENSATION
The
following table sets forth the total cash compensation, paid to or earned
during
each of our last three fiscal years by (i) our Chief Executive Officer and
(ii) our other executive officer whose salary and bonus exceeded $100,000
for the fiscal year ended June 30, 2006 (collectively referred to herein as
the “Named Executive Officers”).
|
SUMMARY
COMPENSATION TABLE
|
|||||||||
|
Annual
Compensation
|
Long
Term Compensation
|
||||||||
|
Awards
|
Payouts
|
||||||||
|
Name
&
Position
|
Fiscal
|
Salary
($)
(1)
|
Bonus
($)
(1)
|
Other
Annual
Compensation
($)
|
Restricted
Stock
Awards
($)
|
Securities
Underlying
Options
SARS
(#)
|
L/TIP
Payouts
($)
|
All
Other
Compensation
($)(3)
|
|
|
Shinichi
Kanemoto
|
06/30/2006
|
$310,249
|
0
|
0
|
0
|
0
|
0
|
0
|
|
|
(President
and CEO)
|
06/30/2005
|
$342,593
|
0
|
0
|
0
|
0
|
0
|
0
|
|
|
|
|
|
|
||||||
|
06/30/2004
|
$346,352
|
0
|
0
|
0
|
0
|
0
|
0
|
||
|
Eiichi
Kanemoto
|
06/30/2006
|
$206,891
|
0
|
0
|
0
|
0
|
0
|
0
|
|
|
|
|
|
|
|
|||||
|
(Secretary)
|
06/30/2005
|
$228,395
|
0
|
0
|
0
|
0
|
0
|
0
|
|
|
|
|
||||||||
|
|
06/30/2004
|
$229,187
|
0
|
0
|
0
|
0
|
0
|
0
|
|
(1)
The
salary and bonus figures represent the compensation paid to the Named
Officers
by our wholly-owned operating subsidiary, Marugin International, Inc. in
their respective capacities as officers of such subsidiary.
(2)
We
do not
currently provide any contingent or deferred forms of compensation arrangements,
annuities, pension or retirement benefits to its directors, officers
or
employees.
Director
Compensation
We
entered into an agreement with Mark Buck, our sole independent director,
effective January 1, 2006, which continues until the last date of
Mr. Buck's current term as a member of our Board of Directors. The
Agreement will be automatically renewed in the event that Mr. Buck is
reelected to our Board of Directors.
Pursuant
to the agreement, Mr. Buck is paid an annual retainer of $18,000 and $500
per Board meeting attended. The Agreement also provides that Mr. Buck
shall receive an annual grant of stock options in an amount to be determined
by
the Board of Directors. No options have been granted to Mr. Buck as of
June 30,
2006.
ITEM
11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The
following table sets forth certain information known to the Company regarding
the beneficial ownership of its capital stock as of June 30,
2006:
20
•
each
person known to beneficially own more than five percent of a class of
capital
stock;
•
each
officer and director of the Company (including proposed directors);
and
•
all
directors and executive officers as a group.
|
Title
of Class
|
|
Name
of Beneficial Owner
|
|
Amount
and
Nature
of Beneficial Owner
|
|
Percent
of
Class
|
|
|
Class E
Convertible
Preferred Stock
|
|
Gakushin
Kanemoto
|
|
1,455,900
shares
Chairman
CFO and
Director
|
|
15
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Shinichi
Kanemoto
|
|
38,823,999
shares
President,
CEO and Director
|
|
40
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Eiichi
Kanemoto
|
|
38,823,999
shares
Secretary
and Director
|
|
40
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Mark
Buck
|
|
No
shares
Director
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Tomiko
Hayakawa
|
|
1,455,900
shares
5%
shareholder
|
|
15
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Taiki
Kanemoto
|
|
8,250,100
shares
5%
shareholder
|
|
8.5
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
Kousei
Kanemoto
|
|
8,250,100
shares
5%
shareholder
|
|
8.5
|
%
|
|
|
|
|
|
|
|
|
|
|
Class E
Convertible
Preferred Stock
|
|
All
directors and named executive officers as a group
(4 persons)
|
|
79,103,898
shares
|
|
81.5
|
%
|
21
The
above
shares of Class E preferred stock represent 91.5% of the total voting
power of
all shares of capital stock. There are no holders of our common stock
which own five percent (5%) or more of the outstanding shares of common
stock on
a fully-diluted basis.
ITEM
12. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
We
have
borrowed money from certain of our major shareholders pursuant to unsecured
promissory notes which are due June 1, 2012. The aggregate
outstanding principal balance as of June 30, 2006, is approximately
$673,000. The notes bear interest at the rate of 2% per annum, with
interest payable month. Payments made during the years ended June 30,
2006 and
2005 were approximately $181,000 and $101,000, respectively. There were
no new
advances during these two fiscal years.
We
also
lease certain land and buildings from certain of our major shareholders.
The lease terms range from two (2) to five (5) years and expire
through 2010. Total payments made in connection with these leases for the
years ended June 30, 2006 and 2005 were $102,064 and $124,120,
respectively. Our management believes these leases are near market
rates.
ITEM
13. EXHIBITS
| 31.1 |
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
| 31.2 |
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
| 32 |
Certification
of Chief Executive Officer and Chief Financial Officer pursuant
to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES
The
following summarizes aggregate fees for professional audit services rendered
by
McKennon, Wilson & Morgan LLP during fiscal years ended May 31, 2006 and
2005:
|
|
2006
|
2005
|
|||||
|
Audit
Fees
|
$
|
216,100
|
$
|
201,000 | |||
|
Audit
Related
|
-
|
-
|
|||||
|
Tax
Fees
|
-
|
-
|
|||||
|
All
Other Fees
|
10,000
|
-
|
|||||
|
Total
Fees
|
$
|
226,000
|
$
|
201,000
|
Audit
Fees pertain to the audit of our annual consolidated financial statements
for
fiscal year 2006 and 2005 and reviews of our quarterly consolidated financial
statements during such fiscal years. All other fees for fiscal year 2006
relate
to procedures performed in connection with the Company's reverse
acquisition.
22
ITEM
7. FINANCIAL STATEMENTS
PGMI,
INC. (FORMERLY HAPS USA, INC.) AND SUBSIDIARY
|
Consolidated
Financial Statements
|
|
||
|
|
|
|
|
|
|
|
||
|
|
|
||
|
|
|
||
|
|
|||
|
|
|
||
F-1
Board
of
Directors
PGMI,
Inc. and subsidiary
We
have
audited the accompanying consolidated balance sheet of PGMI, Inc.
and subsidiary
(the "Company") as of June 30, 2006, and the related consolidated
statements of
operations and comprehensive income (loss), shareholders' equity
and cash flows
for each of the two years in the period ended June 30, 2006. These
consolidated
financial statements are the responsibility of the Company's management.
Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public
Company
Accounting Oversight Board (United States). Those standards require
that we plan
and perform the audit to obtain reasonable assurance about whether
the financial
statements are free of material misstatements. An audit includes
examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial
statements. An audit also includes assessing the accounting principles
used and
significant estimates made by management, as well as evaluating
the overall
financial statement presentation. We believe that our audits provide
a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above
present fairly,
in all material respects, the consolidated financial position of
PGMI, Inc. and
subsidiary as of June 30, 2006, and the consolidated results of
their operations
and their cash flows for each of the two years in the period ended
June 30,
2006, in conformity with accounting principles generally accepted
in the United
States of America.
The
accompanying consolidated financial statements have been prepared
assuming the
Company will continue as a going concern. As discussed in Note
2, the Company
has incurred losses, has a working capital deficiency at June 30,
2006 and has
commitments to fund new store expansions. These factors raise substantial
doubt
about its ability to continue as a going concern. Management’s plans with
respect to these matters are also described in Note 2. The accompanying
consolidated financial statements do not include any adjustments
that might
result from the outcome of this uncertainty.
As
discussed in Note 1, PGMI, Inc. and subsidiary completed a reverse
acquisition
with HAPS USA, Inc., a blank-check company, on December 9, 2005.
The financial
statements previously reported by HAPS USA, Inc. were retroactively
restated for
all periods reported to reflect the historical consolidated financial
position,
results of operations and cash flows of PGMI, Inc. and
subsidiaries.
/s/
McKennon, Wilson & Morgan LLP
Irvine,
California
September
25, 2006
F-2
CONSOLIDATED
BALANCE SHEET
|
June
30, 2006
|
||||
|
ASSETS
(Note 6)
|
||||
|
Current
assets:
|
||||
|
Cash
|
$
|
8,185,205
|
||
|
Time
deposit (Note 2)
|
1,353,310
|
|||
|
Prizes
|
870,237
|
|||
|
Cash
surrender value of life insurance
|
659,990
|
|||
|
Deferred
income taxes (Note 9)
|
141,231
|
|||
|
Prepaid
expenses and other (Note 5)
|
653,118
|
|||
|
Total
current assets
|
11,863,091
|
|||
|
Property
and equipment, net (Note 4)
|
44,325,387
|
|||
|
Deferred
income taxes (Note 9)
|
1,309,534
|
|||
|
Deposits
and other assets (Note 5)
|
2,742,184
|
|||
|
Total
assets
|
$
|
60,240,196
|
||
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
||||
|
Current
liabilities:
|
||||
|
Accounts
payable
|
$
|
1,619,111
|
||
|
Accrued
liabilities (Note 5)
|
1,626,453
|
|||
|
Current
portion of long-term debt (Note 6)
|
7,274,390
|
|||
|
Current
portion of capital lease obligations (Note 7)
|
1,789,383
|
|||
|
Current
portion of loan payable to shareholders (Note 11)
|
92,847
|
|||
|
Total
current liabilities
|
12,402,184
|
|||
|
Long-term
debt, net of current portion (Note 6)
|
34,322,060
|
|||
|
Capital
lease obligations, net of current portion (Note 7)
|
3,300,189
|
|||
|
Non-current
accrued liabilities (Notes 4, 5 and 6)
|
1,572,868
|
|||
|
Loan
payable to shareholders, net of current portion (Note 11)
|
580,296
|
|||
|
Total
liabilities
|
52,177,597
|
|||
|
Shareholders’
Equity (Note 8):
|
||||
|
Preferred
stock, no par value, 150,000,000 shares authorized:
|
||||
|
Class
A convertible preferred stock, 6,000,000 shares designated,
4,425,285
shares issued and outstanding
|
2,333,683
|
|||
|
Class
B convertible preferred stock, 5,000,000 shares designated,
no
shares issued and outstanding
|
-
|
|||
|
Class
C convertible preferred stock, 1,200,000 shares designated,
no
shares issued and outstanding
|
-
|
|||
|
Class
E convertible preferred stock, 116,595,760 shares designated,
97,059,998
shares issued and outstanding
|
2,115,915
|
|||
|
Common
stock, no par value, 750,000,000 shares authorized,
23,258,671
shares issued and outstanding
|
195,892
|
|||
|
Restricted
retained earnings
|
109,141
|
|||
|
Unrestricted
retained earnings
|
3,089,603
|
|||
|
Accumulated
other comprehensive income
|
218,365
|
|||
|
Total
shareholders’ equity
|
8,062,599
|
|||
|
Total
liabilities and shareholders’ equity
|
$
|
60,240,196
|
||
See
accompanying notes to these consolidated financial statements.
F-3
CONSOLIDATED
STATEMENTS OF OPERATIONS
AND
COMPREHENSIVE LOSS
|
Year
Ended
June
30, 2006
|
Year
Ended
June
30, 2005
|
||||||
|
REVENUES
(Note 10):
|
|||||||
|
Gaming
|
$
|
22,696,178
|
$
|
21,533,976
|
|||
|
Other
|
1,788,968
|
1,703,920
|
|||||
|
Total
revenues
|
24,485,146
|
23,237,896
|
|||||
|
COST
OF REVENUES:
|
|||||||
|
Salaries
and wages
|
4,798,051
|
5,014,771
|
|||||
|
Depreciation
|
7,891,639
|
7,530,845
|
|||||
|
Facilities
and other
|
4,854,019
|
5,553,971
|
|||||
|
Impairments
of property and equipment
|
1,105,037
|
2,876,224
|
|||||
|
Total
cost of revenues
|
18,648,746
|
20,975,811
|
|||||
|
Gross
profit
|
5,836,400
|
2,262,085
|
|||||
|
OPERATING
EXPENSES:
|
|||||||
|
Marketing
and advertising
|
925,822
|
1,086,925
|
|||||
|
General
and administrative
|
3,173,540
|
2,911,995
|
|||||
|
Total
operating expenses
|
4,099,362
|
3,998,920
|
|||||
|
Operating
income (loss)
|
1,737,038
|
(1,736,835
|
)
|
||||
|
OTHER
INCOME (EXPENSE):
|
|||||||
|
Reverse
acquisition fees (Notes 1 and 8)
|
(2,333,683
|
)
|
-
|
||||
|
Interest
income
|
731
|
1,948
|
|||||
|
Interest
expense
|
(1,679,624
|
)
|
(1,572,087
|
)
|
|||
|
Other
income (Notes 2 and 6)
|
822,914
|
895,058
|
|||||
|
Other
expense
|
(1,462
|
)
|
(76,728
|
)
|
|||
|
Total
other expense
|
(3,191,124
|
)
|
(751,809
|
)
|
|||
|
Loss
before provision for income taxes
|
(1,454,086
|
)
|
(2,488,644
|
)
|
|||
|
Provision
(benefit) for income taxes
|
644,801
|
(863,331
|
)
|
||||
|
NET
LOSS
|
$
|
(2,098,887
|
)
|
$
|
(1,625,313
|
)
|
|
|
Change
in foreign currency translation
|
(450,626
|
)
|
(128,942
|
)
|
|||
|
TOTAL
COMPREHENSIVE LOSS
|
$
|
(2,549,513
|
)
|
$
|
(1,754,255
|
)
|
|
|
Basic
and dilutive loss per common share:
|
|||||||
|
Weighted
average number of common shares
Outstanding
|
11,380,773
|
N/A
|
|||||
|
Basic
and dilutive net loss per common share
|
$
|
(0.18
|
)
|
N/A
|
|||
See
accompanying notes to these consolidated financial statements.
F-4
|
Class
A Convertible Preferred Stock
|
Class
E Convertible
Preferred
Stock
|
Common
Stock
|
Restricted
Retained
|
Unrestricted
Retained
|
Accumulated
Other Comprehensive
|
||||||||||||||||||||||||||
|
Shares
|
Amount
|
Shares
|
Amount
|
Shares
|
Amount
|
Earnings
|
Earnings
|
Income
(loss)
|
Totals
|
||||||||||||||||||||||
|
Beginning
balances, as restated,
as
of July 1, 2004,
for
Class E Preferred
shares
issued to PGMI, Inc.
shareholders
in reverse acquisition and
change
in reporting entity (Note 1)
|
-
|
$
|
-
|
97,059,998
|
$
|
2,115,915
|
-
|
$
|
-
|
$
|
102,290
|
$
|
6,926,546
|
$
|
797,933
|
$
|
9,942,684
|
||||||||||||||
|
Foreign
currency
translation
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
(128,942
|
)
|
(128,942
|
)
|
|||||||||||||||||||
|
Net
loss
|
(1,625,313
|
)
|
-
|
(1,625,313
|
)
|
||||||||||||||||||||||||||
|
Legal
appropriations
|
-
|
-
|
-
|
-
|
-
|
-
|
4,676
|
(4,676
|
)
|
-
|
-
|
||||||||||||||||||||
|
Balances
June 30, 2005
|
-
|
-
|
97,059,998
|
2,115,915
|
-
|
-
|
106,966
|
5,296,557
|
668,991
|
8,188,429
|
|||||||||||||||||||||
|
Shares
retained by
existing
shareholders after reverse
acquisition
|
3,018,760
|
-
|
-
|
-
|
18,848,746
|
-
|
-
|
(105,892
|
)
|
-
|
(105,892
|
)
|
|||||||||||||||||||
|
Class
A Convertible Preferred
shares
issued for reverse acquisition
transaction
fee
|
2,121,530
|
2,333,683
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
2,333,683
|
|||||||||||||||||||||
|
Conversion
of Class A Convertible
Preferred
shares into common stock
|
(715,005
|
)
|
-
|
-
|
-
|
3,575,025
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||||||
|
Common
stock issued for
settlements
of accounts
payable
|
-
|
-
|
-
|
-
|
534,900
|
105,892
|
-
|
-
|
-
|
105,892
|
|||||||||||||||||||||
|
Stock
issued for future services
|
-
|
-
|
-
|
-
|
300,000
|
90,000
|
-
|
-
|
-
|
90,000
|
|||||||||||||||||||||
|
Foreign
currency
translation
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
(450,626
|
)
|
(450,626
|
)
|
|||||||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
(2,098,887
|
)
|
-
|
(2,098,887
|
)
|
|||||||||||||||||||
|
Legal
appropriations
|
-
|
-
|
-
|
-
|
-
|
-
|
2,175
|
(2,175
|
)
|
-
|
-
|
||||||||||||||||||||
|
Balances
June 30, 2006 (Note 8)
|
4,425,285
|
$
|
2,333,683
|
97,059,998
|
$
|
2,115,915
|
23,258,671
|
$
|
195,892
|
$
|
109,141
|
$
|
3,089,603
|
$
|
218,365
|
$
|
8,062,599
|
||||||||||||||
See
accompanying notes to these consolidated financial
statements.
F-5
|
|
Year
Ended
June
30, 2006
|
Year
Ended
June
30, 2005
|
|||||
|
Cash
flows from operating activities:
|
|||||||
| Net loss | $ | (2,098,887 | ) | $ | (1,625,313 |
)
|
|
|
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
|||||||
|
Depreciation,
amortization and accretion expense
|
7,967,235
|
7,861,256
|
|||||
|
Impairment
of property and equipment (Note 4)
|
1,105,037
|
2,876,224
|
|||||
|
Stock
compensation (Note 8)
|
2,333,683
|
||||||
|
Gain
on sale of investment (Note 1)
|
-
|
(497,680
|
)
|
||||
|
Gain
on interest swap contracts (Note 6)
|
(650,235
|
)
|
(173,565
|
)
|
|||
|
Changes
in operating assets and liabilities:
|
|||||||
|
Prizes
|
(312,728
|
)
|
(141,822
|
)
|
|||
|
Deferred
income taxes
|
354,872
|
(911,571
|
)
|
||||
|
Prepaid
expenses and other
|
226,827
|
119,157
|
|||||
|
Accounts
payable
|
(362,511
|
)
|
(3,080,114
|
)
|
|||
|
Accrued
liabilities
|
655,634
|
738,306
|
|||||
|
Net
cash provided by operating activities
|
9,218,927
|
5,164,878
|
|||||
|
Cash
flows from investing activities:
|
|||||||
|
Capital
expenditures
|
(10,764,844
|
)
|
(8,309,660
|
)
|
|||
|
Time
deposits and restricted cash
|
(536,238
|
)
|
6,177,823
|
||||
|
Proceeds
from liquidation of investment
|
-
|
566,705
|
|||||
|
Other
assets
|
(261,536
|
)
|
(960,081
|
)
|
|||
|
Net
cash used in investing activities
|
(11,562,618
|
)
|
(2,525,213
|
)
|
|||
|
Cash
flows from financing activities:
|
|||||||
|
Payments
on capital lease obligations
|
(1,738,690
|
)
|
(1,302,971
|
)
|
|||
|
Borrowings
of long-term debt
|
12,404,435
|
11,129,322
|
|||||
|
Payments
on long-term debt
|
(7,644,432
|
)
|
(9,963,608
|
)
|
|||
|
Payments
on loan payable to shareholders
|
(180,964
|
)
|
(101,010
|
)
|
|||
|
Net
cash provided by (used in ) financing activities
|
2,840,349
|
(238,267
|
)
|
||||
|
Foreign
currency effect on cash
|
(268,448
|
)
|
(607,499
|
)
|
|||
|
Net
increase in cash
|
228,210
|
1,793,899
|
|||||
|
Cash,
beginning of year
|
7,956,995
|
6,163,096
|
|||||
|
Cash,
end of year
|
$
|
8,815,205
|
$
|
7,956,995
|
|||
|
Non-cash
investing and financing transactions:
|
|||||||
|
Allocation
to restricted retained earnings
under
legal requirements
|
$
|
2,175
|
$
|
4,676
|
|||
|
Purchases
of equipment under capital
leases
|
201,931
|
5,520,048
|
|||||
|
Increase
in property and equipment due to
asset
retirement obligations
|
-
|
800,472
|
|||||
|
Common
stock issued for future services
|
90,000
|
-
|
|||||
|
Cash
paid for :
|
|||||||
|
Interest
|
$
|
1,685,394
|
$
|
2,007,184
|
|||
|
Income
taxes
|
16,550
|
-
|
|||||
See
accompanying notes to these consolidated financial
statements.
F-6
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 - ORGANIZATION AND BUSINESS
MARUGIN
International, Inc., (“MARUGIN”), a Japanese corporation, was incorporated on
December 22, 1972. On June 10, 2003, MARUGIN established PGMI, Inc. (“PGMI”), a
Delaware corporation, to effect a share-exchange agreement with MARUGIN,
whereby
MARUGIN became a wholly-owned subsidiary of PGMI (collectively, the “Company”).
The Company operated thirteen (13) stores and 4.290 machines as of June
30,
2006, which offers Pachinko (Japanese pinball) gaming entertainment, all
of
which except two are located in Nagano prefecture. In July 2004 and March
2005,
the Company opened its two largest stores with 560 machines, each. In July
2005,
the Company closed its smallest store which operated 138 machines. The
Company
receives income from cigarettes, non-alcoholic beverages and sundry items,
as
well as one small batting cage and a bowling alley. Japanese law regulates
Pachinko gaming and the local police enforce laws. Pachinko gaming is one
of the
largest business segments in Japan.
Acquisition
On
December 9, 2005, pursuant to an Agreement and Plan of Reorganization dated
October 27, 2005 (the “Agreement”) by and among HAPS USA, Inc.
(“HAPS”), PGMI, Inc., a Delaware corporation (“PGMI”) and all of the
stockholders of PGMI, HAPS acquired all of the issued and outstanding shares
of
PGMI in exchange for an aggregate of 97,059,998 shares of the Company’s
Class E Preferred Stock, or approximately 91.5% of the voting stock on a
fully-diluted basis (see Note 8 for designations). The Company incurred a
2% merger fee in the form of Class A Preferred Stock (Note 8) with a value
of $2,333,683 in connection with this transaction, which was charged to
expense.
At
the
time of acquisition, HAPS had no revenues and no significant assets or
liabilities. It was considered a blank-check company prior to the
acquisition. The acquisition of PGMI by HAPS was accounted for as a
reverse acquisition, whereby the assets and liabilities of PGMI were reported
at
their historical cost. The net liabilities of HAPS were recorded at fair
value on December 9, 2005, the date of close, totaling approximately
$105,892. The effects of stockholders’ equity will be reported as a
recapitalization. No goodwill will be recorded in connection with the
reverse acquisition. The reverse acquisition resulted in a change in
reporting entity of HAPS for accounting and reporting purposes.
Accordingly, the financial statements reported herein have retroactively
restated for all periods presented to report the historical financial position,
results of operations and of cash flows of PGMI.
The
unaudited pro forma balance sheet data are not significant because of the
lack
of operating assets and liabilities of HAPS. The pro forma results of
operations, assuming the acquisition was completed at the beginning of
the
reporting period, would have caused our net losses to increase, but not
materially, because of the limited operating losses reported by HAPS.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Acquisition
of Entity Under Common Control and Principles of Consolidation
The
acquisition of MARUGIN by PGMI was accounted for at historical cost because
the
entities are under common control. The consolidated results of operations
for
the periods reported herein include the historical results of operations
of
MARUGIN and PGMI since June 10, 2003. All share data have been retroactively
restated to reflect that of PGMI. All significant inter-company transactions
have been eliminated in consolidation.
F-7
Management’s
Plans
The
Company has incurred losses during the year ended June 30, 2006 totaling
approximately $2,099,000. The Company may continue to incur losses during
fiscal
2007 largely due to start-up costs to be incurred with the new store expansions.
At June 30, 2006, the Company has a working capital deficit of approximately
$539,000. Furthermore, the Company is in the process of its store expansion,
which it has remaining obligations under construction contracts of two
new
stores totaling $7,850,000 as of June 30, 2006. The Company requires additional
capital lease, debt and/or equity financing of approximately $6,360,000
to
acquire equipment and machines, as well as provide working capital to fund
initial start-up costs associated with the two new store openings. These
factors
raise substantial doubt about the Company’s ability to continue as a going
concern. Management has historically had good relations with its banks
and
management believes that certain notes payable will be refinanced in the
normal
course of business based on historical actions. Management is seeking equity
financing of approximately $5,000,000. Management has historically had
good
relations with its financing sources and they have been successful in obtaining
financing from traditional sources in Japan at historically low interest
rates.
There are no absolute assurances that management will continue to be successful
in refinancing the notes or raising additional capital. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management
to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ
from
those estimates. Significant estimates made by management include the evaluation
of impairment of property and equipment, cost of swap contracts, valuation
of
series A convertible preferred stock, and valuation allowances for deferred
tax
assets. Management believes that their estimates are reasonable.
Fair
Value of Financial Instruments
Financial
instruments consist of cash, time deposits, accounts payable, short and
long-term debt.
The fair
value of financial instruments approximated their carrying values at June
30,
2006.
Cash
Equivalents
The
Company considers highly liquid investments with an original maturity of
90 days
or less from the purchase date to be cash equivalents. During the periods
presented, there were no cash equivalents outstanding.
The
Company maintains deposits in the United States and Japanese banks which
are not
federally insured.
Time
Deposits
The
Company invests in time deposits with original maturities of one to three
years.
Time deposits maturing in excess of one year from the balance sheet date
are
classified as long-term time deposits. At June 30, 2006 interest rates
on
certificates of deposits were 0.03% to 0.07%. Time deposits are carried
at cost.
Prizes
Prizes
consist of gaming prizes and sundry items and are stated at cost.
F-8
Property
and Equipment
Property
and equipment is stated at cost, less accumulated depreciation. Interest
costs
related to construction projects is capitalized. Major betterments
are
capitalized, while routine repairs and maintenance are charged to expense
when
incurred. Depreciation, which includes assets under capital leases,
is computed
using the straight-line method or an accelerated method over the following
estimated
useful
lives:
| Buildings and improvements | 3 to 28 years |
| Pachinko machines and equipment | 2 to 10 years |
| Leasehold improvements | Estimated life of asset or term of lease, whichever is shorter |
When
purchased new, pachinko machines generally have a useful life of two
(2) to
three (3) years; however, technology changes and changes in patron
playing
habits may cause pachinko machines to become underutilized. Management
evaluates
utilization of machines daily. In the event certain machines become
underutilized, management must sell or dispose of the assets, and replace
these
as determined economical by management. Historically, sales proceeds
from
machines have been minimal.
Statement
of Financial Accounting Standards (“SFAS”) No. 143 “Accounting for Asset
Retirement Obligations,” requires that a liability for the fair value of an
asset retirement obligation be recognized in the period which it is
incurred,
with the offsetting associated asset retirement cost capitalized as
part of the
carrying amount of the long-lived asset. The Company adopted SFAS No.
143 for
all periods presented, the effects of which are discussed in Note
4.
SFAS
No.
144, “Accounting for Impairment or Disposal of Long-Lived Assets,” requires that
long-lived assets, such as property and equipment and purchased intangibles
subject to amortization, be reviewed for impairment whenever events
or changes
in circumstances indicate that the carrying amount of an asset may
not be
recoverable, or at least annually. Recoverability of the asset is measured
by
comparison of its carrying amount to undiscounted future net cash flows
the
asset is expected to generate. Specifically, management projects undiscounted
cash flows expected over the period to be benefited. If such assets
are
considered to be impaired, the impairment to be recognized is measured
as the
amount by which the carrying amount of the asset exceeds its fair market
value.
Estimates of expected future cash flows represent management’s best estimate
based on currently available information and reasonable and supportable
assumptions. Any impairment recognized in accordance with SFAS No.
144 is
permanent and may not be restored. See Note 4 for discussion of impairments
of
property and equipment.
Lease
Accounting
The
Company lease land and certain equipment used in its operations. Some
land lease
have definite terms specified under the agreements, which is generally
twenty
(20) years, and some lease have no specified term or no written contract,
whereby the lessee has rights to use the land indefinitely, so long
as rental
payments are made timely. All land leases are accounted for as operating
lease
as defined under SFAS No. 13 “Accounting for Leases”. Equipment leases generally
have terms of four (4) to five (5) years, which generally represent
to life of
the assets. Accordingly, all significant leases are accounted for as
capital
leases. Buildings and improvements on leased land are generally amortized
over
the term of lease of twenty (20) years, unless the life of the assets
is less.
Buildings and improvements on leased land whereby there is no specified
term are
generally depreciated over the estimated life of the asset.
Investment
On
October 1, 2004, an investment partnership was terminated and Marugin
received
$566,705 resulting in a gain from this investment in the amount of
$497,680
during the year ended June 30, 2005, which is included in other income
in the
accompanying consolidated statement of operations and comprehensive
loss.
F-9
Use
Taxes
Japanese
use taxes are imposed on all revenue and purchase transactions at 5%.
The
Company records use taxes payable based on wagers. In addition, the
Company
records a receivable for use taxes based on purchases. At each reporting
date,
the Company records an offset to the use taxes payable. The Company
may have a
use tax payable or receivable at its reporting dates. The Company records
use
taxes on a net, not gross basis.
Debt
Issue and Interest Swap Costs
Costs
paid in connection with borrowings are capitalized and amortized over
the term
of the debt using the effective interest method.
Costs
of
interest swap agreements are capitalized and amortized over the terms
of the
interest swap agreements (see Note 6).
Interest
Rate Swap Agreements
Interest
rate swap agreements (see Note 6) are considered ineffective against
changes in
the fair value of the debt due to changes in the benchmark interest
rates over
their terms. As a result, as provided by SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended by SFAS No. 149,
changes in fair value of these derivative instruments are recorded
as gains and
losses in the accompanying consolidated statements of operations and
comprehensive loss as other income (expense). The fair value of the
swaps is
carried as an asset or a liability in the consolidated balance sheet
and the
carrying value of the hedged debt is adjusted accordingly. The fair values
of the Company’s interest rate swaps are the estimated amounts it would receive
or pay to terminate the agreements as of the reporting date.
Revenue
Recognition
Revenues
from pachinko and pachislot games represent the gross pay-ins, less
payouts to
customers. Revenues are recorded when cash is received for game balls or
game tokens when rented to the patrons.
Payouts
are recorded when the token prizes are purchased back from the exchangers.
Other revenues for beverage are recognized at the time of sale. Deferred
revenues consist of payments received by the Company related to the
exclusive
rights for beverage and food vending machines to third-party vendors,
and
unredeemed prizes as well as, unused prepaid cards. The revenues of
the
exclusive rights are recognized either over the term of the contract
or based
upon an agreed upon percentage of disbursements from the vending
machines.
Advertising
Advertising
costs are expensed as incurred. Advertising expenses for the years
ended June
30, 2006 and 2005 were $925,761 and $725,043, respectively.
Foreign
Currency
The
functional currency of the Company is the Japanese Yen. The financial
statements
of the Company are translated into United States Dollars (the reporting
currency) at year-end exchange rates for assets and liabilities, and
weighted-average exchange rate for revenues and expenses. The resulting
translation adjustments are recorded as a component of other comprehensive
loss
reflected on the consolidated statements of operations and comprehensive
loss,
and the consolidated statements of shareholders’ equity. Transaction gains and
losses, if any, in foreign currencies are reflected in operations.
During the
years ended June 30, 2006 and 2005, there were no foreign currency
transaction
gains or losses.
F-10
Income
Taxes
The
Company accounts for its income taxes in accordance with SFAS No. 109,
“Accounting for Income Taxes”. Under SFAS No. 109, deferred tax assets and
liabilities are determined based on temporary differences between bases
used for
financial reporting and income tax reporting purposes. Income taxes
are provided
based on the enacted tax rates in effect at the time such temporary
differences
are expected to reverse. A valuation allowance is provided for certain
deferred
tax assets if it is more likely than not that the Company will not
realize tax
assets through future operations. The Company and its subsidiaries
file separate
national and local income tax returns in Japan and the United States
of
America.
Comprehensive
Loss
Comprehensive
loss is defined as the change in equity of a business enterprise during
a period
from transactions, and other events and circumstances from non-owner
sources,
including foreign currency translation adjustments.
Accumulated other comprehensive loss at June 30, 2006, consisted of
cumulative
foreign currency translation gains of $218,365, a decrease of $450,626
during
the year ended June 30, 2006.
Per
Share information
The
Company presents basic earnings per share ("EPS") and diluted EPS on
the face of
all statements of operations. Basic EPS is computed as net loss divided
by the
weighted average number of common shares outstanding for the period.
Diluted EPS
reflects the potential dilution that could occur from common shares
issue able
through stock options, warrants, and other convertible securities that
are
exercisable during or after the reporting period. In the event of a
net loss,
such incremental shares are not included in EPS since their effects
are
anti-dilutive.
The
following is a table of common stock equivalents for the years ended
June 30,
2006 and 2005, which were not considered in the calculation of diluted
net loss
per share as the effects would have been anti-dilutive:
|
2006
|
2005
|
|||
|
Shares
used in the
calculation
of basic
EPS,
as reported
|
11,380,773
|
-
|
||
|
Effects
of series A
convertible
preferred
|
22,126,425
|
-
|
||
|
Effects
of series E
convertible
preferred
|
485,299,990
|
485,299,990
|
||
|
Shares
used in the
calculation
of
diluted
EPS
|
518,807,188
|
485,299,990
|
Recent
Accounting Pronouncements
In
December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which
revises SFAS No. 123. SFAS No. 123(R) is effective for annual periods
that begin
after June 15, 2005 and requires companies to expense the fair value
of employee
stock options and other forms of stock-based compensation. This expense
will be
recognized over the period during which an employee is required to
provide
services in exchange for the award. Currently, the Company does not
have any
outstanding stock options, and as such, SFAS No. 123(R) will not have
an impact
on the consolidated financial statements.
F-11
In
May 2005 the FASB issued SFAS No. 154, “Accounting Changes and Error
Corrections,” which becomes effective for annual periods beginning after
December 15, 2005, our fiscal 2007. This Statement requires that a
voluntary change in accounting principle be retrospectively applied
to prior
period’s financial statements unless it is impractible to do so. Our financial
statements will be affected by SFAS No. 154 only if we voluntarily change
an accounting principle or correct an error in previously issued statements.
In
June 2006 the FASB issued Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes,” (“FIN No. 48”) which becomes effective for
fiscal years beginning after December 15, 2006. While we have not fully
assessed the potential impact on our financial statements of adopting
the
interpretation in fiscal 2008, we do not believe the impact will be
material.
FIN No. 48 clarifies the accounting in accordance with SFAS No. 109,
“Accounting for Income Taxes,” by prescribing a recognition threshold and
measurement attribute for the financial statement recognition and measurement
of
a tax position taken or to be taken in a tax return. It also provides
guidance
on derecognition, classification, interest and penalties, accounting
in interim
periods, disclosure, and transition.
NOTE
3 - RISKS AND UNCERTAINTIES
Innovations
in Technologies
The
Company’s gaming machines are subject to new innovations and changes in
entertainment experiences. Pachinko machines vary widely in price and
expected
life. Rapid changes in demand will render a machine under-producing
and
potentially obsolete.
Cyclical
Nature of Business
The
Company’s primary business involves gaming entertainment. During periods of
recession or economic downturn, consumers may reduce or eliminate spending
on
gaming entertainment activities. In the event that any of the Company’s
demographic markets suffer adverse economic conditions, the Company’s revenues
may be materially adversely affected. In addition, the operations of
the
pachinko stores are typically seasonal in nature. The sales during
the holiday
seasons are higher than the regular months. The biggest holiday season
in Japan
lies in the end of December through the beginning of January. Additionally,
revenues can fluctuate when a new type of pachinko machine is introduced
at the
stores.
Japanese
Gaming Regulation
The
Company’s business is regulated. The Entertainment Establishment Control Law
(“EECL”) governs a variety
of entertainment establishments, including pachinko and pachislot stores.
The
National Public Safety Commission (“NPSC”) sets out the general standard of the
pachinko stores within the scope of EECL. The ability of the Company
to remain
in business and to operate profitably depends upon the Company’s ability to
satisfy all applicable NPSC gaming laws and regulations governed by
EECL.
Political
Climate
The
Company’s ability to remain in the gaming business depends on the continued
political acceptability of pachinko gaming activities to both the public
and
governmental officials. In addition, the gaming laws regulate payout
rates
which, if altered, may diminish the Company’s profitability. Management is aware
of nothing to indicate that NPSC officials will change its policies
toward
gaming activities in general; however, there are no assurances that
such
policies will not be changed. Any substantial, unfavorable change in
the
enabling laws or tax rates on gaming revenues could make the Company’s business
substantially more onerous, less profitable or illegal, which would
have a
material adverse effect on the Company’s business.
F-12
Competition
The
Company faces substantial competition in each of the markets in which
its gaming
facilities are located. Some of the competitors have significantly
greater name
recognition and financial and marketing resources than the Company.
Such
competition results, in part, from the geographic concentration of
competitors.
All of the Company’s gaming operations primarily compete with other gaming
operations in their geographic areas. New expansion and development
activity is
occurring in each of the relevant markets, which may be expected to
intensify
competitive pressures.
Foreign
Currency
Since
the
local currency is the Japanese Yen, the Company may experience significant
fluctuations in the value of reported assets and liabilities in United
States
Dollars. The exchange rate on June 30, 2006 used for translation of
assets and
liabilities was 116.32. The average rates during the years ended June
30, 2006
and 2005, used to translate income and expense accounts, were 114.94
and 106.92,
respectively. As of September 25, 2006, the exchange rate was
116.60.
NOTE
4 - PROPERTY AND EQUIPMENT
At
June 30, 2006, property and equipment consisted of the following:
|
Land
|
|
$
|
15,985,199
|
|
|
Buildings
and improvements
|
|
|
25,427,940
|
|
|
Leasehold
improvements
|
12,384,405
|
|||
|
Pachinko
machines and computer equipment
|
28,077,514
|
|||
|
Construction
in progress
|
3,350,166
|
|||
|
|
|
85,225,224
|
|
|
|
Less
accumulated depreciation and impairments
|
|
|
(40,899,837
|
)
|
|
|
$
|
44,325,387
|
Land
Acquisitions
During
the year ended June 30, 2006, the Company acquired several parcels
of land for
use in the construction of one new store. The aggregate purchase
price was
$1,612,358, including commissions of $302,911.
Construction
in Progress
From
time
to time, the Company enters into contracts for design, construction
and exterior
finishing of its stores. During the year ended June 30, 2006, management
entered
into contracts for the design and construction of two new stores
aggregating
approximately $11,650,000. Management commenced planning of Bando
store in
February 2006 and they expect to open the store in October 2006.
Management
commenced planning of Gyoda store in November 2005 and they expect
to open this
store in December 2006. Additionally, the Company acquired land and
land lease
rights for its Bando location.
During
the year ended June 30, 2006, the Company has incurred construction
costs
including the acquisition of the land for Bando and Gyoda amounting
to
approximately $1,640,000 and $2,150,000, respectively. Total estimated
costs at
completion for Bando and Gyoda are approximately $8,650,000 and $9,360,000,
respectively.
The
Company commenced planning of three other stores, Toyota, Tenri,
and Hikone
during the fiscal year ended June 30, 2006. The Company paid monies
for land
deposits and commissions to intermediaries related to the sites.
In addition,
the Company entered into contracts for the construction of the sites;
however,
the contracts are not final unless certain conditions such as the
permits to
develop are granted. During the year ended June 30, 2006, the Company
incurred
costs related to these three sites amounting to approximately
$1,120,000.
F-13
Impairment
of long- Lived Assets
No
impairments of land and buildings were recorded by management during the
year
ended June 30, 2006. During the year ended June 30, 2005, the Company impaired
land and building at two stores resulting in loss of $738,871, because
of
declining estimated cash flows.
Other
Impairments
As
discussed in Note 2, pachinko machines that are under utilized because
of change
in players’ habits are generally retired before the end of the machine lives.
During the years ended June 30, 2006 and 2005, the Company impaired and
retired
pachinko and pachislot machines prior to the end of their useful lives
resulting
in losses of $1,105,037 and $2,137,353, respectively. The machine impairments
in
fiscal 2005 primarily related to the early disposition of newly acquired
machines to open the two new stores which commenced in July 2004 and March
2005.
Asset
Retirement Obligations
The
Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,”
during fiscal year 2003 and applied this change retroactively to all previous
years effected. The statement requires that a liability for the fair value
of an
asset retirement obligation be recognized in the period which it is incurred,
with the offsetting associated asset retirement cost capitalized as part
of the
carrying amount of the long-lived asset. The asset retirement cost is
subsequently allocated to expense using a systematic and rational method
over
the useful life of the related asset. Changes in the asset retirement obligation
resulting from the passage of time are recognized as an increase in the
carrying
amount of the liability and as an accretion expense. Under certain lease
agreements in which the Company leases land, while owning the building
and/or
parking lot located on that land, the Company is required to return the
land to
its original condition at the end of the land lease term. The lessor has
the
option to require the Company to return the land to its original condition.
It
has been determined that in all cases the lessors will require the Company
to
restore the land. The Company used an average risk free rate of 2.25% to
discount the estimated obligations and a 20-year useful life for their
retired
assets in computing the net retirement obligations as of June 30, 2006.
SFAS
No.
143 has resulted in the establishment of $1,092,185 of costs to long-lived
assets under leasehold improvements. Accretion expense for the years ended
June
30, 2006 and 2005, were $26,770 and $14,933, respectively. At June 30,
2006, the
Company has aggregate non-current accrued liabilities amounting to
$1,202,072.
The
reconciliation of the asset retirement obligation for the year ended June
30,
2006 is as follows:
|
Balance,
July 1, 2005 - foreign currency effected
|
$
|
1,175,302
|
||
|
Liability
accrued
|
-
|
|||
|
Accretion
expense
|
26,770
|
|||
|
Balance,
June 30, 2006
|
$
|
1,202,072
|
Depreciation
Depreciation
expense charged to operations related to property and equipment during
the years
ended June 30, 2006 and 2005 was $7,891,639 and $7,720,727, respectively.
F-14
NOTE
5 - BALANCE SHEET DATA
At
June
30, 2006, prepaid expenses and other consisted of the following:
| Prepaid interest-current | $ |
335,591
|
||
| Prepaid rent |
169,473
|
|||
|
Professional
fees
|
|
|
115,000
|
|
|
Other
|
33,054
|
|||
|
$
|
653,118
|
At
June
30, 2006, deposits and other assets consisted of the following:
|
Deposits
|
|
$
|
1,040,552
|
|
|
Unamortized
interest swap cost
|
692,065
|
|||
|
Debt
issue costs
|
|
|
660,574
|
|
|
Long-term
savings account
|
|
|
165,741
|
|
|
Prepaid
interest non-current
|
153,488
|
|||
|
Other
|
29,764
|
|||
|
$
|
2,742,184
|
At
June
30, 2006, accrued liabilities consisted of the following:
|
Use
taxes payable
|
$
|
342,753
|
||
|
Income
taxes payable
|
268,853
|
|||
|
Professional
fees
|
293,105
|
|||
|
Deferred
revenue
|
243,849
|
|||
|
Salaries
and related benefits
|
|
146,631
|
|
|
|
Reserve
for bonuses
|
|
|
101,711
|
|
|
Utilities
|
80,717
|
|||
|
Property
tax
|
75,533
|
|||
|
Other
|
73,301
|
|||
|
$
|
1,626,453
|
At
June
30, 2006, non-current accrued liabilities consisted of the
following:
|
Asset
retirement obligations
|
|
$
|
1,202,072
|
|
|
Interest
swap liability
|
|
|
180,889
|
|
|
Benefit
plan obligation
|
189,907
|
|||
|
$
|
1,572,868
|
NOTE
6 - LONG-TERM DEBT
Long-Term
Debt
Long-term
debt at June 30, 2006、
consisted of the following:
|
Loans
payable to commercial bank, payable monthly in principal and
interest
installments ranging from $7,170 to $17,916, interest at 3.175%-3.425%
per
annum, due 2006 through 2014, secured by land and buildings,
guaranteed by
officers
|
$
|
3,135,781
|
|
F-15
|
Loans
payable to commercial bank, payable monthly in principal and
interest
installments ranging from $3,078 to $71,699, interest at 2.375%-3.375%
per
annum, due 2006 through 2012, secured by land and buildings,
guaranteed by
officers
|
5,266,781
|
|||
|
Loans
(two) payable to finance company, payable monthly in principal
and
interest installments of $27,591 and $45,725, interest at 2.47%
and 4.0%
per annum, due 2006 through 2012, secured by real property, guaranteed
by
officers
|
3,490,318
|
|||
|
Notes
payable to commercial bank, principal due in January 2008, interest
at
2.5% per annum, secured by land and buildings, guaranteed by
officers
|
9,852,132
|
|||
|
Bond
payable to commercial bank, payable semiannually in principal
of $429,849,
coupon interest at 0.9% per annum, guarantee fee at 1.4%, due
2006 through
2011, with a lump-sum payment of $859,698 in March 2011, unsecured.
See
interest swap agreements discussed below
|
4,728,336
|
|||
|
Bond
payable to commercial bank, payable semiannually in principal
of $322,387,
initially coupon interest at 0.21% per annum, thereafter variable
(Nikkei
Quick DM131) plus 0.1% per annum at thereafter, guarantee fee
at 1.1%, due
2006 through 2012, with a lump-sum payment of $107,462 in December
2012
|
3,976,100
|
|||
|
Loans
payable to commercial bank, payable monthly in principal and
interest
installments from $4,298 to $28,628, interest at 2.5% and 3.75%
per annum,
due 2006 through 2012, unsecured, guaranteed by officers
|
2,813,970
|
|||
|
Loan
payable to commercial bank, payable monthly in principal and
interest
installments of $4,986, interest at 4.5% per annum, due 2006
through 2008,
unsecured, guaranteed by officers
|
111,419
|
|||
|
Loan
payable to commercial bank, payable monthly in principal and
interest
installment of $28,654, interest at 3.5% per annum, due 2006
through 2010,
unsecured, guaranteed by officers
|
1,318,243
|
|||
|
Loan
payable to commercial bank, monthly in principal and interest
installment
of $25,791, interest at 2.425% per annum, due 2006 through 2007
with a
lump-sum payment of $42,985 in November 2007, unsecured, guaranteed
by
officers
|
455,640
|
|
Bond
payable to commercial bank, payable semiannually in principal
of $483,580,
coupon interest at 1.54% guarantee fee at 1.65% per annum, due
2006
through 2013, with a lump-sum payment of $644,773 in March 2013,
unsecured. See interest swap agreements discussed below
|
6,447,730
|
|||
|
Total
long-term debt
|
41,596,450
|
|||
|
Less
current portion
|
(7,274,390
|
)
|
||
|
Long-term
debt, net of current portion
|
$
|
34,322,060
|
F-16
Bond
Payable
On
March
24, 2004, MARUGIN issued a bond payable in the amount of approximately
$6,500,000 (¥700,000,000), which bears a coupon rate of 0.9% and matures on
March 24, 2011. In connection with the above obligations, the Company
was
required to enter into three (3) interest swap arrangements (see next
paragraph). In addition, it was required to pay debt issue costs of
approximately $280,000. The unamortized cost was $157,707 as of June
30, 2006.
The effective interest rate is 4.49%. The bonds are
unsecured.
On
December 30, 2005, the Company issued a bond payable in the amount of
approximately $4,300,000 (¥500,000,000), which bears initially a coupon rate of
0.21%, thereafter variable (Nikkei Quick DM 131) + 0.1%, and guarantee
fee at
1.1% per annum and matures December 25, 2012. In addition, it was required
to
pay bond issue cost of $242,606. The unamortized cost was $212,281 as
of June
30, 2006. The effective interest rate is 3.59%. The bonds are
unsecured.
On
March
31, 2006, the Company issued a bond payable in the amount of approximately
$6,500,000 (¥750,000,000), which bears a coupon rate of 1.54% and guarantee fee
at 1.65% per annum and matures on March 24, 2011. In addition, it was
required
to pay bond issue cost of $309,957. The unamortized cost was $290,584
as of June
30, 2006. The effective interest rate is 3.79%. The bonds are
unsecured.
Interest
Swap Agreements
MARUGIN
entered into two interest rate swap
agreements in 2003 and an interest rate swap agreement in 2004 with a
commercial
bank. First, MARUGIN entered into an agreement in the face amount of
¥1,100,000,000
(approximately $10,150,000), which expires on July 20, 2010. In connection
therewith, MARUGIN agreed to pay interest at 1.555%, per annum on the
face
amount, offset by the receipt of interest at the 3-month TIBOR ("Tokyo
Interbank
Offered Rate") (0.12% per annum at June 30, 2006). Interest payments
commenced
on October 20, 2004 and are payable every three (3) months thereafter
until
expiration. The notional amount does not decline over the term of the
agreement.
Secondly,
MARUGIN entered into an agreement in the
face amount of ¥200,000,000
(approximately $1,840,000), which expires on September 27, 2010. In connection
therewith, MARUGIN agreed to a contract to pay interest at 1.97% per
annum on
the face amount, offset by the receipt of interest at the 3-month TIBOR.
Interest payments commenced on December 25, 2003 and are payable every
three (3)
months thereafter until expiration. The notional amount does not decline
over
the term of the agreement.
Lastly,
MARUGIN entered into an interest rate swap
agreement in the face amount of ¥350,000,000
(approximately $3,230,000), which expires on June 24, 2011. In connection
therewith, MARUGIN agreed to a contract to pay interest at 2.275%, per
annum on
the face amount, offset by the receipt of interest at the 3-month TIBOR.
Interest payments will commence on September 24, 2005 and are payable
every
three (3) months thereafter until expiration. the notional amount declines
over
the term of the agreement.
The
Company entered into the interest swap contracts to obtain financing,
and
therefore, effectively a cost of the borrowings. On the date the contracts
were executed, the fair value of the contract was a cost and liability
in the
amount of approximately $1,031,000. The fair values of MARUGIN’s interest
rate swaps are the estimated amounts it would receive or pay to terminate
the
agreements as of the reporting dates as determined by the bank. As of June
30, 2006, the fair value of the outstanding interest swaps was a liability
in
the amount of $180,889. During the years ended June 30, 2006 and
2005, the Company recorded an unrealized gain totaling $650,244 and $173,565.
Unamortized cost is $692,065 at June 30, 2006, and amortization in 2006
and
2005 was approximately $152,000 and $145,000 respectively. The
effective interest cost of the related debt, after considering the costs
of the
interest swaps and debt issue costs is approximately
6.72%
Future
annual minimum principal payments under long-term debt contracts as of June
30,
2006 are as follows:
|
Years
ending June 30,
|
||||
|
2007
|
$
|
7,274,390
|
||
|
2008
|
15,891,394
|
|||
|
2009
|
4,775,971
|
|||
|
2010
|
4,575,395
|
|||
|
2011
|
3,996,106
|
|||
|
Thereafter
|
5,083,194
|
|||
|
Total
long-term debt
|
$
|
41,596,450
|
||
F-17
NOTE
7 - COMMITMENTS AND CONTINGENCIES
Guarantees
During
the normal course of business, the Company’s shareholders and officers have made
certain guarantees under which it may be required to make payments in relation
to certain Company transactions. The Company indemnifies its directors,
officers, employees and agents to the maximum extent permitted under the
laws of
the State of California and Japan. Historically, the Company nor its
shareholders and officers have been obligated to make significant payments
for
these obligations and no liabilities have been recorded for these indemnities
and guarantees in the accompanying consolidated balance sheet.
Benefit
Plan Obligation
The
Company’s benefit plan was terminated during the fiscal year 2005 as the size of
the Company grew and it was no longer eligible to participate in the small
business plan. Participant accounts were deposited with the Company, as trustee,
until it sponsors a new plan. The participants’ assets were deposited into a
time deposit, earning interest and the benefit obligation in reflected as
a
non-current liability (Note 5). No contributions were made during the years
presented.
Consulting
Agreement
On
June
1, 2002, MARUGIN entered into an annual agreement with a company which requires
payments of approximately $11,000 per month. The contract will be renewed
annually and currently expires on
June
1,
2005. The Company provides information technology and management consulting
to
MARUGIN. During the years ended June 30, 2006 and 2005, the Company incurred
expenses of $125,283 and $123,924, respectively.
Directors
Agreement
On
January, 1, 2006, management entered into a director agreement for a period
of
one year, renewable annually by mutual consent if the director is re-elected.
In
connection therewith, the Company will pay the director a retainer of $1,500
per
month plus $500 per meeting attended and reimbursement of out of pocket
expenses.
On
June
17, 2003, the Company retained one outside director for a US subsidiary.
The agreement provided for an annual payment of $150,000, plus
reimbursement of reasonable expenses. The agreement expired on June 16,
2004.
Another agreement was executed which paid $10,000, and had contingent
consideration which was not met; the agreement was cancelled. On March
1, 2005,
a new agreement was executed with this director, as well as one other director,
which provide for annual compensation of $100,000, plus reasonable expenses.
During the year ended June 30, 2005, the Company paid and incurred $50,000
to
one director. During the year ended June 30, 2006, the Company paid and
incurred
an aggregate of $220,000 to these two directors.
Capital
Leases
The
Company leases equipment under leases that qualify as capital leases. These
leases are for a term of five years and expire in March 2009. Future annual
minimum lease payments for equipment accounted for as capital leases as of
June
30, 2006 are as follows:
|
Years
ending June 30,
|
||||
|
2007
|
$
|
1,965,456
|
||
|
2008
|
1,734,510
|
|||
|
2009
|
1,453,310
|
|||
|
2010
|
268,513
|
|||
|
Total
minimum lease payments
|
5,421,789
|
|||
|
Less
amounts representing interest
|
(332,217
|
)
|
||
|
Present
value of future minimum lease payments
|
5,089,572
|
|||
|
Less
current portion of capital lease obligations
|
(1,789,383
|
)
|
||
|
Capital
lease obligations, net of current portion
|
$
|
3,300,189
|
||
F-18
Interest
expense related to capital lease obligations amounted to $246,206 and $245,226
during the years ended June 30, 2006 and 2005, respectively.
Property
and equipment at June 30, 2006, include the following amounts for capitalized
leases:
|
Equipment
under capital leases
|
$7,123,594
|
|||
|
Less
accumulated depreciation
|
(2,846,702
|
)
|
||
|
Equipment
under capital leases, net
|
$
|
4,276,892
|
||
Operating
Leases
The
Company leases land for four (4) of its existing stores, whereby it has incurred
the costs of the buildings and improvements. The Company also leases land
at six
(6) other existing locations for store parking lots. Minimum monthly rental
payments under these leases range from $22 to $30,712 per month, aggregating
total payments of $79,110 per month. Under Japanese custom, if significant
improvements are made to the leased land, the land leases are required to
be
extended by the lessor for as long as the Company is in operation. The Company
has made significant modifications to the land through construction of buildings
and parking lots. Thus, the terms of the land leases in most cases are
continuous; however, certain leases, in fact, specify land lease terms from
1
year to 30 years. The Company also leases land from two of its officers.
The
monthly lease payments to the officers are $8,505 and the contracts expire
on
April 30, 2007 and June 30, 2008 (Note 11). For the years ended June 30,
2006
and 2005, total rental expense under all land leases was approximately
$1,141,492 and $1,000,657, respectively.
Future
annual minimum payments under non-cancelable operating leases as of June
30,
2006, are as follows:
|
Years
ending June 30,
|
||||
|
2007
|
$
|
861,901
|
||
|
2008
|
824,742
|
|||
|
2009
|
771,582
|
|||
|
2010
|
768,743
|
|||
|
2011
|
768,657
|
|||
|
Thereafter
|
10,377,664
|
|||
|
Total
future annual minimum lease payments
|
$
|
14,373,289
|
||
NOTE
8 - SHAREHOLDERS' EQUITY
Restricted
Retained Earnings
As
required under Japanese laws, the Company must accumulate 10% of dividends
paid
until restricted retained earnings amounts to 25% of common stock. As of
June
30, 2006, the Company was in satisfaction of this requirement.
Class
A Convertible Preferred Stock
Each
share of Class A convertible preferred stock is convertible into five
shares of common stock. In addition, each share of Class A
convertible preferred stock is entitled to five votes. 2,121,530 shares of
Class A convertible preferred stock were issued to a placement agent in
connection with the reverse acquisition. The shares were valued at $2,333,683
based on the average closing price of the Company’s common stock for a period of
time before and after the merger, including a 10% discount. No liquidation
preference exists and no dividends shall accrue under the Class A convertible
preferred stock.
F-19
During
the year ended June 30, 2006, the holders of the Class A convertible preferred
stock converted 715,005 shares of Class A convertible preferred stock into
3,575,025 shares of common stock.
Class
E Convertible Preferred Stock
Each
share of Class E convertible preferred stock is convertible into five
shares of common stock, commencing on December 9, 2008. As a result
of this transaction, PGMI is now wholly-owned subsidiary, and the PGMI
Stockholders own approximately 91.5% of the Company’s voting stock, on a
fully-diluted basis. In addition, each share of Class E convertible
preferred stock is entitled to five (5) votes. No liquidation preference
exists and no dividends shall accrue under the Class E convertible preferred
stock.
Dividends
During
the years ended June 30, 2006 and 2005, the Company did not pay cash
dividends.
Common
Stock
During
the year ended June 30, 2006, the Company issued 300,000 share of common
stock
for future services related to investor relations on behalf of the Company.
The
services commenced in July 2006. Accordingly, the estimated fair value
of the
common stock of $90,000 or $0.30 per share based on the closing price on
the
date of issuance and has been reflected in prepaids and other current assets
as
of June 30, 2006. See Note 12 for issuance of additional stock to the investor
relations company subsequent to year end.
NOTE
9 - INCOME TAXES
The
following summarizes the provision (benefit) for income taxes for the years
ended June 30, 2006 and 2005:
|
2006
|
2005
|
||||||
|
Current
-
|
|||||||
|
Foreign
|
$
|
289,929
|
$
|
48,240
|
|||
|
Deferred
-
|
|||||||
|
Foreign
|
354,872
|
(911,571
|
)
|
||||
|
Provision
(benefit) for income taxes
|
$
|
644,801
|
$
|
(
863,331
|
)
|
||
A
reconciliation of the expected statutory national income tax provision
to the
provision (benefit) for income taxes for the years ended June 30, 2006
and 2005,
is as follows:
|
2006
|
2005
|
||||||
|
Provision
for income taxes at a federal statutory rate
|
30.0
|
%
|
30.0
|
%
|
|||
|
Increase
(reduction) in income taxes resulting from:
|
|
|
|||||
|
Local
income taxes, net of national benefit
|
9.6
|
%
|
9.0
|
%
|
|||
|
Permanent
items not deductible for income tax purposes
|
6.0
|
%
|
(0.9
|
%)
|
|||
|
Increase
in valuation allowance
|
(89.9
|
%)
|
(4.5
|
%)
|
|||
|
Provision
(benefit) for income taxes
|
(44.3
|
%)
|
(33.6
|
%)
|
|||
F-20
At
June
30, 2006 significant components of the Company's net deferred taxes are
as
follows:
|
2006
|
||||
|
Deferred
tax assets (liabilities)-
|
||||
|
Current
assets - accrued liabilities and deferred revenue
|
$
|
141,231
|
||
|
Noncurrent
assets:
|
|
|||
|
Impairment
charges
|
1,293,481
|
|||
|
Depreciation
and other
|
568,832
|
|||
|
Net
operating loss carryforward - United States
|
1,901,339
|
|||
|
Less
- valuation allowance
|
(1,901,339
|
)
|
||
|
Total
noncurrent deferred tax assets
|
1,862,313
|
|||
|
Noncurrent
liabilities:
|
||||
|
Interest
swap liability
|
(274,058
|
)
|
||
|
Other
|
(278,721
|
)
|
||
|
Total
noncurrent deferred tax liabilities
|
(552,779
|
)
|
||
|
Net
noncurrent deferred tax assets
|
$
|
1,309,534
|
||
Management
increased its valuation allowance by $1,307,224 and $112,291 during the
years
ended June 30, 2006 and 2005, respectively, for certain expenses paid in
the
United States that will not be deductible in Japan. At the present time,
management cannot determine if there will be income in the United States
to
offset such expenses, which will be carried forward as net operating losses.
As
of June 30, 2006, the net operating losses begin to expire in eighteen
years for
United States federal tax purposes and three years for the State of California
tax purposes. Prior year net operating loss carryforward in Japan in the
amount
of $1,789,765 was fully utilized in June 30, 2006.
NOTE
10 - GAMING OPERATIONS
The
Company derives revenue primarily from the operation of pachinko and pachislot
games. The Company is subject to annual licensing requirements established
by
the Prefectural Public Safety Commission. The Company must renew this license
yearly to operate. The Company pays sales taxes of 5% of net revenues.
A summary
of gross wagers, less winning patron payouts, for the years ended June
30, 2006
and 2005, are as follows:
|
2006
|
2005
|
||||||
|
Gross
Wagers
|
$
|
187,972,786
|
$
|
187,877,668
|
|||
|
Patron
Payouts
|
$
|
(165,276,608
|
)
|
$
|
(166,343,692
|
)
|
|
|
Gaming
Revenues
|
$
|
22,696,178
|
$
|
21,533,976
|
|||
NOTE
11 - RELATED PARTY TRANSACTIONS
Loans
Payable to Shareholders
Loans
payable to shareholders consisted of three (3) notes which are due June
1, 2012,
interest is due monthly at 2% per annum, unsecured, in the amount of $673,143.
Payments made during the years ended June 30, 2006 and 2005 were
$180,964 and $101,010, respectively. There were no new advances during the
periods presented.
F-21
Leases
with Shareholders
The
Company leases certain land and buildings from certain of its
shareholders. The terms range from two (2) to five (5) years, expiring at
times ranging from 2007 to 2010. Total payments made in connection with
these leases for the year ended June 30, 2006 and for the year ended June
30,
2005 were $102,064 and $124,120, respectively. Management believes these
leases are near market rates.
Fourth
Quarter Adjustment
During
the quarterly period ended March 31, 2006, the Company inadvertently wrote
off
the 441 pachinko machines that were in storage, which are to be used in
the new
stores expected to open in fiscal 2007. In addition, the Company
incorrectly reduced the carrying value of the pachinko machines through
a charge
to operations. These charges are deemed an error by management, not a change
in
estimate, and accordingly, a required restatement of previously reported
amounts. During the fourth quarter ended June 30, 2006, management reversed
the
amounts that incorrectly reduced the carrying value of pachinko machines
totaling $428,580. Accordingly, the Company restated its net income during
the
quarterly period ended March 31, 2006, as follows:
|
Unaudited
|
||||||||||
|
For
the Three Months Ended
|
||||||||||
|
March,
31, 2006
|
March,
31, 2006
|
|||||||||
|
(as
reported)
|
Adjustments
|
(as
adjusted)
|
||||||||
|
Net
Income
|
$
|
161,858
|
$
|
428,580
|
$
|
590,438
|
||||
|
Basic
net income per
share
|
$
|
0.01
|
$
|
0.03
|
||||||
|
Dilutive
net income
per
share
|
$
|
0.00
|
$
|
0.00
|
||||||
NOTE
12 - SUBSEQUENT EVENTS
Short-term
Debt
In
July
and August 2006, the Company entered into two additional short-term debt
agreements with two commercial banks totaling approximately $860,000. The
loans
are primarily used for paying income taxes and new store construction. The
loans
bear interest rates of 2.625% and 2.9% per annum and are due in six months
and
one year.
Issuance
of Common Stock
On
August
15, 2005, the Company issued 1,700,000 shares of common stock to the investor
relation company noted at Note 8. The estimated fair value of the common
stock
of $459,000 or $0.27 per share was based on the closing price of the Company’ s
common stock on the date of issuance and will be expensed over the period
of
services provided.
F-22
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
|
PGMI,
INC.
|
||
| |
|
|
| Date: September 28, 2006 | By: |
/s/ Shinichi
Kanemoto
|
|
Shinichi
Kanemoto
Chief
Executive Officer
(Principal
Executive Officer)
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in their
capacities and on the dates indicated.
|
Signature
|
Capacity
|
Date
|
|
|
/s/ Shinichi
Kanemoto
|
Chief
Executive Officer, Principal
|
September
28,
2006
|
|
|
Shinichi
Kanemoto
|
Executive
Officer and Director
|
||
|
/s/ Gakushin
Kanemoto
|
Chief
Financial and Principal
|
September
28,
2006
|
|
|
Gakushin
Kanemoto
|
Accounting
Officer and Director
|
||
|
/s/ Eiichi
Kanemoto
|
Secretary
and Director
|
September
28,
2006
|
|
|
Eiichi
Kanemoto
|
|||
|
/s/ Mark
Buck
|
Director
|
September
28,
2006
|
|
|
Mark
Buck
|
|||
23